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(1) | Ares Management, L.P. common shareholders have limited voting rights and have no right to remove our general partner or, except in the limited circumstances described below, elect the directors of our general partner. On those few matters that may be submitted for a vote of our common shareholders, Ares Voting LLC, an entity owned and controlled by Ares Partners Holdco LLC, which is in turn owned and controlled by the Holdco members, holds a special voting share that provides it with a number of votes, on any matter that may be submitted for a vote of our common shareholders, that is equal to the aggregate number of vested and unvested Ares Operating Group Units held directly or indirectly by the limited partners of the Ares Operating Group that do not directly hold a special voting share. See “Material Provisions of Ares Management, L.P. Partnership Agreement—Withdrawal or Removal of the General Partner,” “—Meetings; Voting” and “—Election of Directors of General Partner.” |
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(2) | Assuming the full exchange of Ares Operating Group Units for our common shares, Ares Management, L.P. holds 100% of the Ares Operating Group and Ares Owners Holdings L.P., Alleghany, ADIA and the public hold 71.59%, 5.88%, 12.73% and 9.80%, respectively, of Ares Management, L.P. |
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(3) | Each Ares Operating Group entity has both common units and a series of preferred units with economic terms designed to mirror those of the Series A Preferred shares (“GP Mirror units”) outstanding.
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(4) | Alleghany is expected to exchange all of its Ares Operating Group Units for our common shares in 2018. |
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(5) | As of December 31, 2017, Ares Management, L.P. was treated as a partnership for U.S. federal income tax purposes. Effective March 1, 2018, Ares Management, L.P. will be treated as a corporation for U.S. federal income tax purposes. Ares Management, L.P.'s legal structure will remain a Delaware limited partnership. |
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(6) | The Ares Operating Group is comprised of Ares Holdings L.P., Ares Offshore Holdings L.P. and Ares Investments L.P. |
Holding Company Structure
The Company has elected to be treated as a corporation for U.S. federal income tax purposes (the “Tax Election”) effective March 1, 2018. In connection with the Tax Election, we have amended and restated our partnership agreement to, among other things, reflect our new tax classification and change the name of our common units and preferred units to common shares and preferred shares, respectively. The terms of such common shares and preferred shares, and the associated rights, otherwise remain unchanged. See "Item 1A. Risk Factors – Our common shareholders do not elect our general partner or, except in limited circumstances, vote on our general partner's directors and have limited ability to influence decisions regarding our businesses."
Accordingly, Ares Management, L.P. and any direct subsidiaries of Ares Management, L.P. that are treated as corporations for U.S. federal income tax purposes and that are the holders of Ares Operating Group Units are (and, in the case of Ares Offshore Holdings, Ltd., may be) subject to U.S. federal, state and local income taxes in respect of their interests in the Ares Operating Group entities. Our legal structure will remain a Delaware limited partnership and the distribution provisions under our limited partnership agreement will remain unchanged. The Ares Operating Group entities are treated as partnerships for U.S. federal income tax purposes. An entity that is treated as a partnership for U.S. federal income tax purposes generally incurs no U.S. federal income tax liability at the entity level. Instead, each partner is required to take into account its allocable share of items of income, gain, loss, deduction and credit of the partnership in computing its U.S. federal, state and local income tax liability each taxable year, whether or not cash distributions are made.
Each of the Ares Operating Group entities has an identical number of partnership units outstanding. Ares Management, L.P. holds, directly or through direct subsidiaries, a number of Ares Operating Group Units equal to the number of common shares that Ares Management, L.P. has issued. The Ares Operating Group Units held by Ares Management, L.P. and its subsidiaries are economically identical in all respects to the Ares Operating Group Units that are not held by Ares Management, L.P. and its subsidiaries. Accordingly, Ares Management, L.P. receives the distributive share of income of the Ares Operating Group from its equity interest in the Ares Operating Group.
The Ares Operating Group Units and our common shares held directly or indirectly by our senior professional owners are generally subject to restrictions on transfer and other provisions. See “Item 11. Executive Compensation.”
Certain Corporate Governance Considerations
Voting Rights. Unlike the holders of common stock in a corporation, our common shareholders have limited voting rights and have no right to remove our general partner or, except in the limited circumstances described below, elect the directors of our general partner. On those few matters that may be submitted for a vote of our common shareholders – certain amendments to our limited partnership agreement, mergers and consolidations and in the limited circumstances described below, election of the directors of our general partner – Ares Voting LLC, an entity wholly owned by Ares Partners Holdco LLC, which is in turn owned and controlled by the Holdco Members, holds a special voting share that provides it with a number of votes, on any matter that may be submitted for a vote of our common shareholders, that is equal to the aggregate number of Ares Operating Group Units held by the limited partners of the Ares Operating Group entities that do not hold a special voting share. We refer to our common shares (other than those held by any person whom our general partner may from time to time, with such person’s consent, designate as a non‑voting common shareholder) and our special voting shares as “voting shares.” Accordingly, on those few matters that may be submitted for a vote of our common shareholders, our public shareholders (other than ADIA) collectively have 9.79% of the voting power of Ares Management, L.P, and the Holdco Members, through Ares Owners Holdings L.P. and the special voting share held by Ares Voting LLC, have approximately 71.59% of the voting power of Ares Management, L.P. Our common shareholders’ voting rights are further restricted by the provision in our partnership agreement stating that any common shares held by a person that beneficially owns 20% or more of any class of our common shares then outstanding (other than our general partner, Ares Owners Holdings L.P., a member of Ares Partners Holdco LLC or their respective affiliates, a direct or subsequently approved transferee of our general partner or its affiliates or a person who acquired such common shares with the prior approval of our general partner) cannot vote on any matter.
Election of Directors. In general, our common shareholders have no right to elect the directors of our general partner. However, when the Holdco Members and other then‑current or former Ares personnel directly or indirectly hold less than 10% of the limited partner voting power, our common shareholders will have the right to vote in the election of the directors of our general partner. This voting power condition will be measured on January 31 of each year, and will be triggered if the total voting power held collectively by (i) holders of the special voting shares in Ares Management, L.P. (including our general partner, members of Ares Partners Holdco LLC and their respective affiliates), (ii) then‑current or former Ares personnel (including indirectly through related entities) and (iii) Ares Owners Holdings L.P. is less than 10% of the voting power of the outstanding voting shares of Ares Management, L.P. For purposes of determining whether the Ares control condition is satisfied, our general partner will treat as
outstanding, and as held by the foregoing persons, all voting shares deliverable to such persons pursuant to equity awards granted to such persons. Unless and until the foregoing voting power condition is satisfied, our general partner’s board of directors will be elected in accordance with its limited liability company agreement, which provides that directors generally may be appointed and removed by the member of our general partner, an entity owned and controlled by the Holdco Members. Unless and until the foregoing voting power condition is satisfied, the board of directors of our general partner has no authority other than that which its member chooses to delegate to it. In the event that the voting power condition is satisfied, the board of directors of our general partner will be responsible for the oversight of our business and operations.
Conflicts of Interest and Duties of Our General Partner. Although our general partner does not engage in any business activities other than the management and operation of our businesses, conflicts of interest may arise in the future between us or our common shareholders, on the one hand, and our general partner or its affiliates or associates, on the other. The resolutions of these conflicts may not always be in our best interests or that of our common shareholders. In addition, we have fiduciary and contractual obligations to the investors in our funds and we expect to regularly take actions with respect to the purchase or sale of investments in our funds, the structuring of investment transactions for those funds or otherwise that are in the best interests of the investors in those funds but that might at the same time adversely affect our near term results of operations or cash flow.
Our partnership agreement limits the liability of, and reduces or eliminates the duties (including fiduciary duties) owed by, our general partner and its affiliates and associates to us and our common shareholders. Our partnership agreement also restricts the remedies available to common shareholders for actions that might otherwise constitute breaches of our general partner’s or its affiliates’ or associates’ duties (including fiduciary duties). Common shareholders are treated as having consented to the provisions set forth in our partnership agreement, including the provisions regarding conflicts of interest situations that, in the absence of such provisions, might be considered a breach of fiduciary or other duties under applicable state law.
Operations Management Group
The OMG consists of five independent, shared resource groups to support our reportable segments by providing infrastructure and administrative support in the areas of accounting/finance, operations/operations, information technology, business development/corporate strategy legal/and relationship management, legal, compliance and human resources. Our clients seek to partner with investment management firms that not only have compelling investment track records across multiple investment products but also possess seasoned infrastructure support functions. As such, significant investments have been made to develop the OMG. We have successfully launched new business lines, integrated acquired businesses into the operations and created scale within the OMG to support a much larger platform in the future.
Organizational Structure
The simplified diagram below (which omits certain intermediate holding companies) depicts our legal organizational structure. Ownership information in the diagram below is presented as of December 31, 2020. Ares Management Corporation is a holding company and through subsidiaries is the general partner of each of the Ares Operating Group entities and operates and controls the business and affairs of the Ares Operating Group. Ares Management Corporation consolidates the financial results of the Ares Operating Group entities, their consolidated subsidiaries and certain consolidated funds.
(1)Assuming the full exchange of Ares Operating Group Units for shares of our Class A common stock, as of December 31, 2020, Ares Owners Holdings L.P. would hold 51.19% and the public would hold 48.81% of Ares Management Corporation.
(2)On February 17, 2021, our board of directors adopted resolutions authorizing a Second Amended and Restated Certificate of Incorporation in connection with an internal reorganization that is expected to occur on or about April 1, 2021. The internal reorganization will consist of, among other matters, a merger of each of Ares Investments and Ares Offshore Holdings, with and into Ares Holdings.
Holding Company Structure
The Company elected to be treated as a corporation for U.S. federal and state income tax purposes (the “Tax Election”) effective March 1, 2018. In addition, the Company completed its state law conversion from a Delaware limited partnership to a Delaware corporation (the “Conversion”) effective on November 26, 2018 (the “Effective Date”). At the Effective Date, (i) each common share of the Company outstanding immediately prior to the Effective Date converted into one issued and outstanding, fully paid and nonassessable share of Class A common stock, $0.01 par value per share, of the Company, (ii) the general partner share of the Company outstanding immediately prior to the Effective Date converted into 1,000 issued and outstanding, fully paid and nonassessable shares of Class B common stock, $0.01 par value per share of the Company, (iii) the special voting share of the Company outstanding immediately prior to the Effective Date converted into one issued and outstanding, fully paid and nonassessable share of Class C common stock, $0.01 par value per share, of the Company, and (iv) each preferred share of the Company outstanding immediately prior to the Effective Date converted into one issued and outstanding, fully paid and nonassessable share of the Series A Preferred Stock.
As a result of the Conversion, except as otherwise expressly provided in the Certificate of Incorporation, our common stockholders are entitled to vote on all matters on which stockholders of a corporation are generally entitled to vote under the Delaware General Corporation Law (the “DGCL”), including the election of our board of directors. Holders of shares of our Class A common stock became entitled to one vote per share of our Class A common stock. On any date on which the Ares Ownership Condition (as defined in the Certificate of Incorporation) is satisfied, holders of shares of our Class B common stock are, in the aggregate, entitled to a number of votes equal to (x) four times the aggregate number of votes attributable to our Class A common stock minus (y) the aggregate number of votes attributable to our Class C common stock. On any date on which the Ares Ownership Condition is not satisfied, holders of shares of our Class B common stock are not entitled to vote on any matter submitted to a vote of our stockholders. The holder of shares of our Class C common stock is generally entitled to a number of votes equal to the number of Ares Operating Group Units (as defined in the Certificate of Incorporation) held of record by each Ares Operating Group Limited Partner (as defined in the Certificate of Incorporation) other than the Company and its subsidiaries. Ares Management GP LLC is the sole holder of shares of our Class B common stock and Ares Voting LLC is the sole holder of shares of our Class C common stock. Our Class B common stock and our Class C common stock are non-economic and holders thereof shall not be entitled to (i) dividends from the Company or (ii) receive any assets of the Company in the event of any dissolution, liquidation or winding up of the Company. Ares Management GP LLC and Ares Voting LLC are both wholly owned by Ares Partners Holdco LLC. As a result, the Company is a “controlled company” within the meaning of the corporate governance standards of the New York Stock Exchange (“NYSE”) and qualifies for exceptions from certain corporate governance rules of the NYSE. Except as provided in the Certificate of Incorporation and the Company’s Bylaws and under the DGCL and the rules of the NYSE, shares of the Series A Preferred Stock are generally non-voting.
Accordingly, Ares Management Corporation and any direct subsidiaries of Ares Management Corporation that are treated as corporations for U.S. federal income tax purposes and that are the holders of Ares Operating Group Units are (and, in the case of Ares Offshore Holdings, Ltd., may be) subject to U.S. federal, state and local income taxes in respect of their interests in the Ares Operating Group entities. The Ares Operating Group entities are treated as partnerships for U.S. federal income tax purposes. An entity that is treated as a partnership for U.S. federal income tax purposes generally incurs no U.S. federal income tax liability at the entity level. Instead, each partner is required to take into account its allocable share of items of income, gain, loss, deduction and credit of the partnership in computing its U.S. federal, state and local income tax liability each taxable year, whether or not cash distributions are made.
Each of the Ares Operating Group entities has an identical number of partnership units outstanding. Ares Management Corporation holds through subsidiaries a number of Ares Operating Group Units equal to the number of shares of Class A common stock that Ares Management Corporation has issued. The Ares Operating Group Units held by Ares Management Corporation and its subsidiaries are economically identical in all respects to the Ares Operating Group Units that are not held by Ares Management Corporation and its subsidiaries. Accordingly, Ares Management Corporation receives the distributive share of income of the Ares Operating Group from its equity interest in the Ares Operating Group.
Structure and Operation of our Funds
We conduct the management of our funds and other similar private vehicles primarily through organizing a partnership or limited liability structure in which entities organized by us accept commitments and/or funds for investment from institutional investors and (to a limited extent) high net worth individuals.other investors. Such commitments are generally drawn down from investors on an as needed basis to fund investments over a specified term. Our Credit Group funds also include hedge funds or structured funds in which the investor’s capital is fully funded into the fund upon or soon after the subscription for interests in the fund. The CLOs that we manage are structured investment vehicles that are generally private companies with limited liability.liability companies. Our drawdown funds and hedge funds are generally organized as limited partnerships or limited liability companies. However, there are non‑U.S.non-U.S. funds that are structured as corporate or non‑non-
partnership entities under applicable law. We also advise a number of investors through SMA relationships structured as contractual arrangements or single investor vehicles. In the case of our SMAs that are not structured as single investor vehicles, the investor, rather than us, generally controls custody of the investments with respect to which we advise. We also manage a closed-end interval fund that allows for periodic redemptions of the various share classes. Three of the vehicles that we manage are publicly traded corporations. The publicly traded corporations do not have redemption provisions or a requirement to return capital to investors upon exiting the investments made with such capital, except as required by applicable law (including distribution requirements that must be met to maintain RIC or REIT status). However, ACRE’s charter includes certain limitations relating to the ownership or purported transfer of its common stock in violation of the REIT ownership requirements.
Our funds are generally advised by Ares Management LLC, which is registered under the Investment Advisers Act of 1940, as amended (the "Investment“Investment Advisers Act"Act”) or a wholly owned subsidiary thereof. Responsibility for the day‑to‑dayday-to-day operations of each investment vehicle is typically delegated to the Ares entity serving as investment adviser pursuant to an investment advisory, (or similar)management or similar agreement. Generally, the material terms of our investment advisory agreements relate to the scope of services to be rendered by the investment adviser to the applicable vehicle, the calculation of management fees to be borne by investors in our investment vehicles and certain rights of termination with respect to our investment advisory agreements. With the exception of certain of the publicly traded corporations,investment vehicles, the investment vehicles themselves do not generally register as investment companies under the Investment Company Act of 1940, as amended (the “Investment Company Act”), in reliance on applicable exemptions thereunder.
The investment management agreements we enter into with clients in connection with contractual SMAs may generally be terminated by such clients with reasonably short prior written notice. Our investment management agreement with ARCC generally must be approved annually by such company’s board of directors (including a majority of such company’s independent directors). In addition to other termination provisions, each investment advisory and management agreement will automatically terminate in the event of its assignment and may be terminated by either party without penalty upon 60 days’ written notice to the other party.
The governing agreements of many of our funds provide that, subject to certain conditions, third‑partythird-party investors in those funds have the right to terminate the investment period or the fund without cause. The governing agreements of some of our funds provide that, subject to certain conditions, third‑partythird-party investors have the right to remove the general partner. In addition, the governing agreements of certain of our funds provide that upon the occurrence of certain events, including in the event that certain “key persons” in our funds depart the firm, do not meet specified time commitments or engage in bad acts, the investment period will be suspended or the investors have the right to vote to terminate the investment period in accordance with specified procedures.
Fee Structure
Management Fees
The investment adviser of each of our funds and certain separately managed accounts generally receivesreceive an annual management fee based uponon a percentage of the fund’s capital commitments, contributed capital, net assetsasset value or invested capital during the investment period and the fund’sbased on invested capital after the investment period, exceptand for the investment advisers to certain of our hedge funds and separately managed accountsSMAs, we receive an annual management fee that is based uponon a percentage of invested capital, contributed capital or net asset value throughout the term of the fund or separately managed account. From time to time weSMA. We also may receive special fees, including commitment, arrangement, underwriting, agency, portfolio management, monitoring and other similar fees, some of which may be accelerated upon a sale of the underlying portfolio investment. In certain circumstances we are contractually required to offset certain amounts of such special fees against future management fees relating to the applicable fund. In addition, we may receive transaction fees from certain affiliated funds for activities related to fund transactions, such as loan originations. These fees are either recognized as other revenue in the period the transaction related services are rendered or amortized over the life of the investment.
The investment adviser of each of our CLOs typically receives annual management fees based upon a percentage of each CLO's total assets, subject to certain performance measures related toon the underlying assets the vehicle owns, and additionalgross aggregate collateral balance for CLOs, at par, adjusted for defaulted or discounted collateral. The management fees which are incentive‑based (that is, subject to meeting certain return criteria). We also classify the ARCC Part I Fees asof CLOs accounted for approximately 3% of our total management fees due to their predictabilityon a consolidated basis and frequency of payments without risk of contingent repayment. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Components of Consolidated Results of Operations—Revenues.”7% on an unconsolidated basis for the year ended December 31, 2020.
The management fees we receive from our drawdown style funds are typically payable on a quarterly basis over the life of the fund and do not depend onfluctuate with the changes in investment performance of the fund (other than to reflect the disposition or decreasefund. The investment management agreements we enter into with clients in value of assets where the management fees are based on invested capital). The management fees we receive from our hedge funds have similar characteristics, except thatconnection with contractual SMAs may generally be terminated by such funds often afford investors increased liquidity through annual, semi‑annual or quarterly withdrawal or redemption rights following the expiration of a specified period of time when capital may not be withdrawn and the amount of management fees to which the investment adviser is entitledclients with respect thereto will proportionately increase as the net asset value of each investor’s capital account grows and will proportionately decrease as the net asset value of each investor’s capital account decreases.reasonably short prior written notice. The management fees we receive from our SMAs are generally paid on a periodic basis (typically quarterly, subject to the termination rights described above) and may alternatively beare based on either invested capital or proportionately increase or decrease based on the net asset value of the separately managed account.
We also receive management fees in accordance with the investment advisory and management agreements we have with the publicly traded vehicles we manage. Base management fees we receive from ARCC are paid quarterly and proportionately increase or decrease based on ARCC’s total assets (other than(reduced by cash and cash equivalents). ARCC Part I Fees are also generally paid quarterly and proportionately increase or decrease based on ARCC’s net investment income (before ARCC Part I Fees and ARCC Part II Fees (as defined in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations—Components of Consolidated Results of Operations—Revenues”)), subject to a fixed hurdle rate. We classify ARCC Part I Fees as management fees as they are predictable and recurring in nature, and not subject to contingent repayment. Management fees we receive from ARDC are generally paid on a regular basis (typically monthly)monthly and proportionately increase or decrease based on the closed‑end funds’closed-end fund's total assets minus such funds’ liabilities (other than liabilities relating to indebtedness). Management fees we receive from ACRE are generally paid on a quarterly basis and proportionately increase or decrease based on ACRE’s stockholders’ equity (as calculated pursuant to the ACREequity. Our investment management agreement)agreements of our permanent capital vehicles must be reviewed or approved annually by their boards of directors (including a majority of its independent directors).
Performance FeesIncome
We may also receive performance feesincome from a majority of our funds whichthat may be either an incentive fee or a special allocation of income, which we refer to as a carried interest, in the event thatinterest. Performance income is recorded by us when specified investment returns are achieved by the fund. We may, and do intypically award certain cases, awardof our senior professionals with participation in such performance fees.income.
Incentive Fees
The general partners, managers or similar entities of certain of our funds receive performance‑performance-based fees. These fees are generally based allocation fees ranging from 10% to 20%on the net appreciation per annum of the applicable fund’s net capital appreciation per annum,fund, subject to certain net loss carry‑forwardcarry-forward provisions, (known ashigh-watermarks and/or preferred returns. Such performance based fees may also be based on a “high‑watermark”). In some cases, the investment adviser of each of our hedge funds and certain SMAs is entitled to an incentive fee generally up to 20% of the applicable fund’s cumulative net appreciation per annum,to date, in some cases subject to a high‑watermark and in some caseshigh-watermark or a preferred return. Incentive fees are realized at the end of a measurement period, typically quarterly or annually. Realized incentive fees are generally higher during the second half of the year due to the nature of certain Credit Group funds that typically realize incentive fees annually. Once realized, the fees earned by our hedge funds generally are not subject to a contingent repayment obligation. Incentive fees are realized at the end of athe calendar year. Once realized, such performance based fees are generally not subject to repayment. Cash from the realizations is typically received in the period subsequent to the measurement period, typically quarterly or annually.period.
Incentive Fees from Publicly TradedVehicles
We also are entitled to receive incentive fees in accordance with the investment advisory and management agreements we have with ARCC and ACRE. We may receive ARCC Part II Fees, which are calculated at the endnot paid unless ARCC achieves cumulative aggregate realized capital gains (net of each applicable year by subtracting (a) the sum of ARCC’s cumulative aggregate realized capital losses and aggregate unrealized capital depreciation from (b) its cumulative aggregate realized capital gains, in each case calculated from October 8, 2004.depreciation). Incentive fees we receive from ACRE are based on a percentage of the difference between ACRE’s core earnings (as defined in ACRE’s management agreement) and an amount derived from the weighted average issue price per share of ACRE’s common stock in its public offerings multiplied by the weighted average number of shares of ACRE's common stock outstanding. We are not entitled to receive incentive fees from ARDC.
Carried Interest
The general partner or an affiliate of certain of our funds may be entitled to receive carried interest from a fund. Carried interest entitles the general partner (or an affiliate) to a special allocation of income and gains from a fund, and is typically structured as a net profits interest in the applicable fund. Carried interest is generally calculated on a “realized gain” basis, and the general partner of a fund is generally entitled to a carried interest between 10% and 20% of the net realized income and gains (generally taking into account unrealized losses) generated by such fund. Net realized income or loss is not netted between or among funds.
Funds generally follow either an American-style waterfall or European-style waterfall. For American-style waterfalls, the general partner is entitled to receive carried interest after a fund investment is realized if the investors in the fund have received distributions in excess of the capital contributed for such investment and all prior realized investments (plus allocable expenses), as well as the preferred return. For European-style waterfalls, the general partner is entitled to receive carried interest if the investors in the fund have received distributions in an amount equal to all prior capital contributions plus a preferred return.
For most funds, the carried interest is subject to a preferred return ranging from 5% to 8%, subject in most cases to a catch‑upcatch-up allocation to the general partner. Generally, if at the termination of a fund (and in some cases at interim points in the life of a fund), the fund has not achieved investment returns that generally exceed the preferred return threshold or the general partner receives net profits over the life of the fund in excess of its allocable share under the applicable partnership agreement, the general partner will be obligated to repay an amount equal to the extent to which performance fees that werethe previously distributed to itcarried interest exceeds the amounts to which the general partner is ultimately entitled. These repayment obligations may be related to amounts previously distributed to us and our senior professionals and are generally referred to as contingent repayment obligations.
Although a portion of any distributionsdividends paid by us to our common shareholders may include carried interest received by us, we do not intend to seek fulfillment of any contingent repayment obligation by seeking to have holders of our Class A common shareholdersstock return any portion of such distributionsdividends attributable to carried interest associated with any contingent repayment obligation. Contingent repayment obligations operate with respect to only a given fund’s own net investment performance only and performance feescarried interest of other funds are not netted for determining this contingent obligation. Although a contingent repayment obligation is several to each person who received a distribution, and not a joint obligation, and our professionals who receive carried interest have guaranteed repayment of such contingent obligation, the governing agreements of our funds generally provide that, if a recipient does not fund his or her respective share, we may have to fund such additional amounts beyond the amount of performance feescarried interest we retained, although we generally will retain the right to pursue remedies against those performance feecarried interest recipients who fail to fund their obligations.
Certain funds may make distributions to their partners to provide them with cash sufficient to pay applicable federal, state and local tax liabilities attributable to the fund's income that is allocated to them. These distributions are referred to as tax distributions and are not subject to contingent repayment obligations.
For additional information concerning the contingent repayment obligations we could face, see “Item 1A. Risk Factors—We may need to pay these contingent“clawback” or “contingent repayment” obligations if and when they are triggered under the governing agreements with our investors.funds.”
Capital Invested In and Through Our Funds
To further align our interests with those of investors in our funds, we have invested the firm’s capital and that of our professionals in the funds we sponsor and manage. General partner capital commitments to our funds are determined separately with respect to our funds and, generally, are less than 5% of the total commitments of any particular fund. We determine the general partner capital commitments based on a variety of factors, including regulatory requirements, investor requirements, estimates regarding liquidity over the estimated time period during which commitments will be funded, estimates regarding the amounts of
capital that may be appropriate for other opportunities or other funds we may be in the process of raising or are considering raising, prevailing industry standards with respect to sponsor commitments and our general working capital requirements. We may from time to timegenerally offer to our senior professionals a partportion of the general partner commitments to our funds.eligible professionals in accordance with the Investment Company Act. Our general partner capital commitments are typically funded with cash and not with carried interest or deferral of management fees. For more information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Sources and Uses of Liquidity.”
Regulatory and Compliance Matters
Our businesses, as well as the financial services industry, generally are subject to extensive regulation, including periodic examinations, by governmental agencies and self‑regulatoryself-regulatory organizations or exchanges in the U.S. and foreign jurisdictions in which we operate relating to, among other things, antitrust laws, anti‑moneyanti-money laundering laws, anti‑briberyanti-bribery laws relating to foreign officials, tax laws and privacy laws with respect to client and other information, and some of our funds invest in businesses that operate in highly regulated industries. Each of the regulatory bodies with jurisdiction over us has regulatory powers dealing with many aspects of financial services, including the authority to grant, and in specific circumstances to cancel, permissions to carry on particular activities. Any failure to comply with these rules and regulations could expose us to liability and/or reputational damage. In addition, additionalAdditional legislation, increasing global regulatory oversight of fundraising activities, changes in rules promulgated by self‑regulatoryself-regulatory organizations or exchanges or changes in the interpretation or enforcement of existing laws and rules, either in the United States or elsewhere, may directly affect our mode of operation and profitability. See “Item 1A. Risk Factors-Risks Related to Our Businesses-ExtensiveRegulation-Extensive regulation in the United States affects our activities, increases the cost of doing business and creates the potential for significant liabilities and penalties that could adversely affect our businesses and results of operations,” “-Failure to comply with “pay to play” regulations implemented by the SEC FINRA and certain states, and changes to the “pay to play” regulatory regimes, could adversely affect our businesses,” “-Regulatory changes and other developments in the United States and regulatory compliance failures could adversely affect our reputation, businesses and operations” and “-Regulatory changes in jurisdictions outside the United States could adversely affect our businesses.businesses,” “-Adverse incidents with respect to ESG activities could impact our or our portfolio companies’ reputation, the cost of our or their operations, or result in investors ceasing to allocate their capital to us, all of which could adversely affect our business and results of operations,” and “-Regulations governing ARCC’s operation as a business development company affects its ability to raise, and the way in which it raises, additional capital.”
Rigorous legal and compliance analysis of our businesses and investments is important to our culture. We strive to maintain a culture of compliance through the use of policies and procedures such as oversight compliance, codes of ethics, compliance systems, communication of compliance guidance and employee education and training. All employees must annually certify their understanding of and compliance with key global Ares policies, procedures and code of ethics. We have a compliance group that monitors our compliance with the regulatory requirements to which we are subject and manages our compliance policies and procedures. Our Chief Compliance Officer together with our Chief Legal Officer, supervises our compliance group, which is responsible for
monitoring all regulatory and compliance matters that affect our activities. Our compliance policies and procedures address a variety of regulatory and compliance risks such as the handling of material non‑publicnon-public information, position reporting, personal securities trading, valuation of investments on a fund‑specificfund-specific basis, document retention, potential conflicts of interest and the allocation of investment opportunities.
Many jurisdictions in which we operate have laws and regulations relating to data privacy, cybersecurity and protection of personal information, including the General Data Protection Regulation, which expands data protection rules for individuals within the European Union (the “EU”) and for personal data exported outside the EU, and the California Consumer Privacy Act, which creates new rights and obligations related to personal data of residents (and households) in California. Any determination of a failure to comply with any such laws or regulations could result in fines and/or sanctions, as well as reputational harm. Moreover, to the extent that these laws and regulations or the enforcement of the same become more stringent, or if new laws or regulations or enacted, our financial performance or plans for growth may be adversely impacted.
United States
The SEC oversees the activities of our subsidiaries that are registered investment advisers under the Investment Advisers Act. The Financial Industry Regulatory Authority (“FINRA”) overseesand the SEC oversee the activities of our wholly owned subsidiary Ares Investor Services LLC ("AIS"(“AIS LLC”), as a registered broker‑dealer.broker-dealer. In connection with certain investments made by funds in our Private Equity Group, certain of our subsidiaries and funds are subject to audits by the Defense Security Service to determine whether we are under foreign ownership, control or influence. In addition, we regularly rely on exemptions from various requirements of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Investment Company Act, the Commodity Exchange Act and ERISA.the U.S. Employee Retirement Income Security Act of 1974, as amended (“ERISA”). These exemptions are sometimes highly complex and may in certain circumstances depend on compliance by third parties who we do not control.
Additionally, the SEC and various self-regulatory organizations have in recent years increased their regulatory activities in respect of investment management firms. See “Item 1A. Risk Factors-Risks Related to Regulation- Extensive regulation affects our activities, increases the cost of doing business and creates the potential for significant liabilities and penalties that could adversely affect our businesses and results of operations.” Effective September 2019, the SEC adopted a rule that requires a broker-dealer, or a natural person who is an associated person of a broker-dealer, to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities, without placing the financial or other interest of the broker, dealer or natural person who is an associated person of a broker-dealer making the recommendation ahead of the interest of the retail customer. The term “retail customer” is defined as a natural person who uses such a recommendation primarily for personal, family or household purposes, without reference to investor sophistication or net worth. The “best interest” standard would be satisfied through compliance with certain disclosure, duty of care, conflict of interest mitigation and compliance obligations. While the rule has been challenged by litigation, full implementation began in June 2020, and compliance with the rule will likely impose additional costs to us, in particular with respect to our product offerings and investment platforms that include retail investors.
Funds and Portfolio Companies of our Funds
All of our funds are advised by SEC registered investment advisers that are registered with the SEC (or wholly owned subsidiaries thereof). Registered investment advisers are subject to more stringent requirements and regulations under the Investment Advisers Act than unregistered investment advisers. Such requirements relate to, among other things, fiduciary duties to clients, maintaining an effective compliance program, managing conflicts of interest and general anti‑fraudanti-fraud prohibitions. In addition, the SEC requires investment advisers registered or required to register with the SEC under the Investment Advisers Act that advise one or more private funds and have at least $150 million in private fund assets under management to periodically file reports on Form PF. We have filed, and will continue to file, quarterly reports on Form PF.PF, which has resulted in increased administrative costs and a significant amount of attention and time to be spent by our personnel.
Further, the SEC has highlighted valuation practices as one of its areas of focus in investment adviser examinations and has instituted enforcement actions against advisers for misleading investors about valuation. If the SEC were to investigate and find errors in our methodologies or procedures, we and/or members of our management could be subject to penalties and fines, which could harm our reputation and our business, financial condition and results of operations could be materially and adversely affected.
ARCC is a registered investment company that has elected to be treated as a business development company under the Investment Company Act. ARDC and certain other funds are registered investment companies under the Investment Company Act. Each of the registered investment companies has elected, for U.S. federal tax purposes, to be treated as a regulated
investment company (“RIC”) under Subchapter M of the U.S. Internal Revenue Code of 1986, as amended (the “Code”). As such, each registered investment company is requiredTo maintain its RIC status under the Code, a RIC must timely distribute an amount equal to distribute at least 90% of its ordinaryinvestment company taxable income and realized,(as defined by the Code, which generally includes net short‑term capital gains in excess of realized net long‑term capital losses, if any, to its shareholders. In addition, to avoid excise tax, each registered investment
company is required to distribute at least 98% of its income (such income to include both ordinary income and net capital gains), which would take into account short‑term and long‑short term capital gains and losses. Each registered investment company, at each ofgains) to its discretions, may carry forward taxable income in excess of calendar year distributions andstockholders. In addition, a RIC generally will be required to pay an excise tax equal to 4% on this income.certain undistributed taxable income unless it distributes in a timely manner an amount at least equal to the sum of (i) 98% of its ordinary income recognized during a calendar year and (ii) 98.2% of its capital gain net income, as defined by the Code, recognized during the one-year period ending on October 31 of the calendar year and (iii) any income recognized, but not distributed, in preceding years. The taxable income on which a RIC pays excise tax is generally distributed to its stockholders in the next tax year. Depending on the level of taxable income earned in a tax year, a RIC may choose to carry forward such taxable income for distribution in the following year, and pay any applicable excise tax. In addition, as a business development company, ARCC must not acquire any assets other than “qualifying assets” specified in the Investment Company Act unless, at the time the acquisition is made, at least 70% of ARCC’s total assets are qualifying assets (with certain limited exceptions). Qualifying assets include investments in “eligible portfolio companies.” ARCC is also generally prohibited from issuing and selling its common stock at a price below net asset value per share and from incurring indebtedness (including for this purpose, preferred stock), if ARCC’s asset coverage, as calculated pursuant to the Investment Company Act, equals less than 150% after such incurrence.
ACRE has elected and qualified to be taxed as a real estate investment trust, or REIT, under the Code. To maintain its qualification as a REIT, ACRE must distribute at least 90% of its taxable income to its shareholdersstockholders and meet, on a continuing basis, certain other complex requirements under the Code.
AIS LLC, our wholly owned subsidiary, is registered as a broker‑dealerbroker-dealer with the SEC, which maintains licenses in many states, and is a member of FINRA. As a broker‑dealer,broker-dealer, this subsidiary is subject to regulation and oversight by the SEC and state securities regulators. In addition, FINRA, a self‑regulatoryself-regulatory organization that is subject to oversight by the SEC, promulgates and enforces rules governing the conduct of, and examines the activities of, its member firms. Due to the limited authority granted to our subsidiary in its capacity as a broker‑dealer,broker-dealer, it is not required to comply with certain regulations covering trade practices among broker‑dealersbroker-dealers and the use and safekeeping of customers’ funds and securities. As a registered broker‑dealerbroker-dealer and member of a self‑regulatoryself-regulatory organization, AIS LLC is, however, subject to the SEC’s uniform net capital rule. Rule 15c3‑115c3-1 of the Exchange Act, which specifies the minimum level of net capital a broker‑dealerbroker-dealer must maintain and also requires that a significant part of a broker‑dealer’sbroker-dealer’s assets be kept in relatively liquid form.
The SEC See “Item 1A. Risk Factors-Risks Related to Our Businesses-Political and various self‑regulatory organizations haveconditions, including the effects of negative publicity surrounding the financial industry in recent years increased their regulatory activities in respect of investment management firms. In July 2010, the Dodd‑Frank Wall Street Reformgeneral and Consumer Protection Act (the “Dodd‑Frank Act”) was signed into law and has imposed significant regulations on nearly every aspect of the U.S. financial services industry.
In October 2011, the Federal Reserve and other federal regulatory agencies issued a proposed rule implementing a section of the Dodd‑Frank Act that has become known as the “Volcker Rule.” The Volcker Rule generally prohibits insured banks or thrifts, any bank holding company or savings and loan holding company, any non‑U.S. bank with a U.S. branch, agency or commercial lending company and any subsidiaries and affiliates of such entities, regardless of geographic location, from investing in or sponsoring “covered funds,” which include private equity funds or hedge funds. The final Volcker Rule became effective on April 1, 2014, and , except with respect to certain foreign banking entities, the conformance period ended on July 21, 2017. It contains exemptions for certain “permitted activities” that would enable certain institutions subject to the Volcker Rule to continue investing in covered funds under certain conditions.
In 2013, the Office of the Comptroller of the Currency, the Department of the Treasury, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation published revised guidance regarding expectations for banks’ leveraged lending activities. This guidance, in addition to the Dodd‑Frank Act risk retention rules approved in October 2014,legislation, could further restrict credit availability, as well as potentially restrict the activities of certain funds who invest in broadly syndicated loans in our Credit Group, which supports many of its portfolio investments from banks’ lending activities.
Pursuant to the Dodd-Frank Act, regulation of the derivatives market is bifurcated between the U.S. Commodities Futures Trading Commission (the “CFTC”) and the SEC. Under the Dodd‑Frank Act, the CFTC has jurisdiction over swaps and the SEC has jurisdiction over security‑based swaps. As part of its Dodd-Frank Act related rule‑making process, the CFTC made changes to its rules with respect to the registration and oversight of commodity pool operators (“CPOs”). Such rules require that an entity that is a CPO must register with the CFTC unless an exemption from registration is available. Previously, the CPO registration rules had applied to the operator of a fund invested in “commodity interests,” meaning that the fund entered into futures or options with respect to commodities. As a result of the CFTC’s revisions to these rules, all swaps (other than security‑based swaps) are now included in the definition of commodity interests. As a result, funds that utilize swaps (whether or not related to a commodity) as part of their business model may fall within the statutory definition of a commodity pool. If a fund qualifies as a commodity pool, then, absent an available exemption, the operator of such a fund is required to register with the CFTC as a CPO. Registration with the CFTC renders such CPO subject to regulation, including with respect to disclosure, reporting, recordkeeping and business conduct.
Certain of our funds may from time to time, directly or indirectly, invest in instruments that meet the definition of a “swap” under the Commodity Exchange Act and the CFTC’s rules promulgated thereunder. As a result, such funds may qualify as commodity pools, and the operators of such funds may need to register as CPOs unless an exemption applies such as the so-called “de minimis” exemption, codified in CFTC rule 4.13(a)(3). If any of our funds cease to qualify for this (or another applicable) exemption, certain Ares entities associated with and/or affiliated with those funds will be required to register with the CFTC as commodity pool operators.
The Dodd‑Frank Act requires the CFTC, the SEC and other regulatory authorities to promulgate certain rules relating to the regulation of the derivatives market. Such rules require or will require the registration of certain market participants, the clearing of certain derivatives contracts through central counterparties, the execution of certain derivatives contracts on electronic platforms, as well as reporting and recordkeeping. The Dodd-Frank Act also provides expanded enforcement authority to the CFTC and SEC. While certain rules have been promulgated and are already in effect, the rulemaking and implementation process is still ongoing. In particular, the CFTC has finalized most of its rules under the Dodd‑Frank Act, and the SEC has proposed a number of rules regarding security‑based swaps but has only finalized some of these rules. We cannot therefore yet predict the ultimate effect of the rules and regulations on our business.
Under CFTC and SEC rules, an entity may be required to register as a major swap participant (“MSP”) or major security-based swap participant (“MSBSP”) if it has substantial swaps or security-based swaps positions or has substantial counterparty exposure from its swaps or security-based swaps positions. If any of our funds were required to register as an MSP or MSBSP, it could make compliance more expensive, affect the manner in which we conduct our businesses and adversely affect our profitability. Additionally, if any of our funds qualify as “special entities” under CFTC rules, it could make it more difficult for them to enter into derivatives transactions or make such transactions more expensive.businesses.”
The CFTC has issued final rules imposing reporting and recordkeeping requirements on swaps market participants. Such rules are currently effective and could significantly increase operating costs. These additional recordkeeping and reporting requirements may require additional compliance resources and may also have a negative effect on market liquidity, which could negatively impact commodity prices and our ability to hedge our price risks.
Pursuant to rules finalized by the CFTC in December 2012 and September 2016, certain classes of interest rate swaps and certain classes of credit default swaps are subject to mandatory clearing, unless an exemption applies. Many of these swaps are also subject to mandatory trading on designated contract markets or swap execution facilities. At this time, the CFTC has not proposed any rules designating other classes of swaps for mandatory clearing, but it may do so in the future. Mandatory clearing and trade execution requirements may change the cost and availability of the swaps that we use, and exposes us to the credit risk of the clearing house through which any cleared swap is cleared. In addition, federal bank regulatory authorities and the CFTC have adopted initial and variation margin requirements for swap dealers, security-based swap dealers, MSPs and MSBSPs (“swap entities”), including permissible forms of margin, custodial arrangements and documentation requirements, for uncleared swaps and security-based swaps. As a result, swap entities will be required to collect margin for transactions and positions in uncleared swaps and security-based swaps by financial end users. The new rules became effective for end users on March 1, 2017. The CFTC’s Division of Swap Dealer and Intermediary Oversight subsequently extended, until September 1, 2017, the time to comply with the variation margin requirements for swaps that are subject to a March 1, 2017 compliance date. The effect of the regulations on us is not fully known at this time. However, these rules may increase the cost of our activity in uncleared swaps and security-based swaps to the extent we are determined to be a financial end user.
In December 2016, the CFTC reproposed rules that would set federal position limits for certain core physical commodity futures, options and swap contracts (“referenced contracts”), and issued final rules on aggregation among entities under common ownership or control, unless an exemption applies, for position limits on certain futures and options contracts that would apply to the proposed position limits on referenced contracts. It is possible that the CFTC could propose to expand such requirements to other types of contracts in the future. The proposal could affect our ability and the ability for our funds to enter into derivatives transactions if and when the CFTC’s position limits rules become effective.
The CFTC has finalized regulations requiring collateral used to margin cleared swaps to be segregated in a manner different from that applicable to the futures market and has finalized other rules allowing parties to an uncleared swap to require that any collateral posted as initial margin be segregated with a third party custodian. Collateral segregation may impose greater costs on us when entering into swaps.
Finally, the Dodd‑Frank Act gave the CFTC expanded anti‑fraud and anti‑manipulation authority, including authority over disruptive trading practices and insider trading. Several investigations have commenced in the United States related to manipulation of the foreign exchange, LIBOR and indices markets. It is possible that new standards will emerge from these proceedings that could impact the way that we trade.
The Dodd‑Frank Act authorizes federal regulatory agencies to review and, in certain cases, prohibit compensation arrangements at financial institutions that give employees incentives to engage in conduct deemed to encourage inappropriate risk‑taking by covered financial institutions. In 2016, federal bank regulatory authorities and the SEC revised and re-proposed a rule that generally (1) prohibits incentive-based payment arrangements that they determine encourage inappropriate risks by certain financial institutions by providing excessive compensation or that could lead to material financial loss and (2) requires those financial institutions to disclose information concerning incentive-based compensation arrangements to the appropriate federal regulator.
The Dodd‑Frank Act also directs the SEC to adopt a rule that requires public companies to adopt and disclose policies requiring, in the event the company is required to issue an accounting restatement, the contingent repayment obligations of related incentive compensation from current and former executive officers. The SEC has proposed but not yet adopted such rule. To the extent the aforementioned rules are adopted, our ability to recruit and retain investment professionals and senior management executives could be limited.
The Dodd‑Frank Act amends the Exchange Act to compensate and protect whistleblowers who voluntarily provide original information to the SEC and establishes a fund to be used to pay whistleblowers who will be entitled to receive a payment equal to between 10% and 30% of certain monetary sanctions imposed in a successful government action resulting from the information provided by the whistleblower.
Many of these provisions are subject to further rulemaking and to the discretion of regulatory bodies, such as the Council and the Federal Reserve. Many of these provisions are subject to further rulemaking and to the discretion of regulatory bodies, such as the Council and the Federal Reserve. On February 3, 2017, President Trump signed Executive Order 13772 (the “Executive Order”) announcing the new administration’s policy to regulate the U.S. financial system in a manner consistent with certain “Core Principles,” including regulation that is efficient, effective and appropriately tailored. The Executive Order directed the Secretary of the Treasury, in consultation with the heads of the member agencies of the Financial Stability Oversight Council, to report to the President on the extent to which existing laws, regulations and other government policies promote the Core Principles and to identify any laws, regulations or other government policies that inhibit federal regulation of the U.S. financial system.
On June 12, 2017, the U.S. Department of the Treasury (“Treasury”) published the first of several reports in response to the Executive Order on the depository system covering banks and other savings institutions. On October 6, 2017, the Treasury released a second report outlining ways to streamline and reform the U.S. regulatory system for capital markets, followed by a third report, on October 26, 2017, examining the current regulatory framework for the asset management and insurance industries. Subsequent reports are expected to address: retail and institutional investment products and vehicles, as well as non‑bank financial institutions, financial technology and financial innovation.
On June 8, 2017, the U.S. House of Representatives passed the Financial Choice Act, which includes legislation intended to repeal or replace substantial portions of the Dodd‑Frank Act. Among other things, the proposed law would repeal the Volcker Rule limiting certain proprietary investment and trading activities by banks, eliminate the authority of regulators to designate asset managers and other large non‑bank institutions as “systemically important financial institutions” or “SIFIs,” and repeal the Department of Labor (“DOL”) “fiduciary rule” governing standards for dealing with retirement plans until the SEC issues standards for similar dealings by broker‑dealers and limiting the substance of any subsequent DOL rule to the SEC standards. The bill was referred to the Senate, where it is unlikely to pass as proposed. On November 16, 2017, a bipartisan group of U.S. Senators, led by Senate Banking Committee Chairman, introduced the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Senate Regulatory Relief Bill”). The Senate Regulatory Relief Bill would revise various post-crisis regulatory requirements and provide targeted regulatory relief to certain financial institutions. Among the most significant of its proposed amendments to the Dodd-Frank Act are a substantial increase in the $50 billion asset threshold for automatic regulation of bank holding companies as SIFIs, an exemption from the Volcker Rule for insured depository institutions with less than $10 billion in consolidated assets and lower levels of trading assets and liabilities, as well as amendments to the liquidity leverage ratio and supplementary leverage ratio requirements. On December 5, 2017, the Senate Banking Committee approved the Senate Regulatory Relief Bill. If the legislation is adopted in the Senate, it remains unclear whether and how it would be reconciled with its House-passed counterpart, the Financial Choice Act, which is substantially different in scope and substance, and ultimately approved by both chambers of Congress. The ultimate impact of this order and its implementation on existing and proposed regulations under the Dodd-Frank Act and other rules and regulations applicable to the U.S. financial system are uncertain; however, such impact could be material to our industry, business and operations.
Other Jurisdictions
Certain of our subsidiaries operate outside the United States. In Luxembourg, Ares Management Luxembourg (“AM Lux”) is subject to authorization and regulation by the Commission de Surveillance du Secteur Financier (“CSSF”). In the United Kingdom (the “U.K.”), Ares Management Limited (“AML”) and Ares Management UK Limited (“AMUKL”) are subject to regulation and authorization by the U.K. Financial Conduct Authority (“the FCA”). Ares European Loan Management LLP (“AELM”), which is not a subsidiary, but in which we are indirectly invested and which procures certain services from Ares Management Limited,AML, is also subject to regulation by the FCA. In some circumstances, Ares Management Limited, Ares Management UK Limited, Ares European Loan Management LLPAML, AMUKL, AELM and other Ares entities are or become subject to UKU.K. or EU laws, for instance in relation to marketing our funds to investors in the European Economic Area (“EEA”(the “EEA”).
The UK is scheduled to leaveU.K. exited the EU in March 2019. Some formon January 31, 2020. The withdrawal agreement between the U.K. and the EU provided for a transitional period to allow for the terms of transitional agreement bythe U.K.'s future relationship with the EU to be negotiated, which UK based financial services firms can continueended on December 31, 2020. EEA passporting rights are no longer available to operate on a cross-border basis seems likely. However, the durationrelevant U.K. entities following the end of the transitional agreementperiod. Various EU laws have been “on-shored” into domestic U.K. legislation and certain transitional regimes and deficiency-correction powers exist to ease the transition. The U.K. and the end-stateEU announced, on December 24, 2020, that they have reached agreement on a new Trade and Cooperation Agreement (the “TCA”), which addresses the future relationship between the UK and EUparties. Notwithstanding the TCA, there remains unclear. There is a risk that following Brexit the UK may be denied accessconsiderable uncertainty as to the single market. Thisnature of the U.K.’s future relationship with the EU (particularly in the sphere of financial services), creating continuing uncertainty as to the full extent to which the businesses of the U.K. Regulated Entities could be highly disruptiveadversely affected by Brexit. See “Item 1A. Risk Factors-Risks Related to Our Businesses-The U.K.’s exit from the EU (“Brexit”) could adversely affect our business and may result in us having to increase our presence in other EEA member states which would result in additional costs.
operations.” Despite the U.K.’s departure from the EU, new and existing EU legislation couldis expected to continue to impact our business in the United KingdomU.K. (whether because its effect is preserved in the U.K. as a matter of domestic policy or because compliance with such legislation (whether in whole or part) is a necessary condition for market access into the EEA) and other EEA member states where we have operations. The followingU.K.'s departure has the potential to change the legislative and regulatory frameworks within which AML, AMUKL and AELM operate, which could adversely affect our businesses or cause a material increase in our tax liability.
AMUKL, AM Lux, AML and AELM (the “European Entities”) all operate within EU legislative frameworks, which include legislation that is both directly applicable to the European Entities and legislation that must be implemented by EEA member states at a national level. Notwithstanding the U.K.'s withdrawal from the EU, AML, AMUKL and AELM as UK-based firms generally continue to be regulated under European legislative frameworks as such frameworks have been preserved in UK law as a matter of policy (subject to amendments to operate properly in a post-Brexit context). When implementing EU measures at a national level, member states often have some degree of discretion as to the manner of implementation, and as a result the rules in some areas are not harmonized across the EEA. In addition, member states may have their own national laws and rules governing the operation of particular relevancefirms in the financial sector which are unrelated to any European legislative initiative. In some circumstances other Ares entities are or become subject to EU laws or the law of EEA member states, including with respect to marketing our funds to investors in the EEA.
AM Lux and AMUKL are both alternative investment fund managers (“AIFMs”). Their operations are primarily governed by Directive 2011/61/EU on Alternative Investment Fund Managers and other associated legislation, rules and guidance (“AIFMD” or the “Directive”). The U.K. implemented AIFMD while it was still a member of the EU and similar requirements therefore continue to apply in the U.K. notwithstanding Brexit. The AIFMD imposes significant regulatory requirements on AIFMs established in the EEA. AIFMD regulates fund managers by, amongst other things, prescribing authorization conditions for an AIFM, restricting the activities that can be undertaken by an AIFM, prescribing the organizational requirements, operating conditions, and regulatory standards relating to such things as initial capital, remuneration, conflicts, risk management, leverage, liquidity management, delegation of duties, transparency and reporting requirement, etc. The European Commission is currently reviewing AIFMD and launched a public consultation in October 2020 on potential improvements to the regulatory framework. This is expected to result in new legislation, possibly in 2021 (commonly referred to as “AIFMD II”). It is unclear at this stage whether and how AIFMD II will affect us or our subsidiaries.
AML and AELM are both investment firms within the meaning of Directive 2014/65/EU on Markets in Financial Instruments (“MiFID II”). The operations of AML and AELM are primarily governed by UK laws and regulatory rules implementing MiFID II, the accompanying Markets in Financial Instruments Regulation 600/2014/EU (“MiFIR”) and other associated legislation, rules and guidance. The main business of the European Entities is to provide asset management services to clients from within the EEA. The European Entities operate primarily within different regulatory frameworks in part because they provide different services to different types of clients.
MiFID II and MiFIR extended the Markets and Financial Instruments Directive (“MiFID”) requirements in a number of areas and require investment firms to comply with more prescriptive and onerous obligations in relation to such things as: costs and charges disclosure, product design and governance, the receipt and payment of inducements, the receipt of and payment for investment research, suitability and appropriateness assessments, conflicts of interest, record-keeping, best execution, transaction and trade reporting, remuneration, training and competence and corporate governance. Although the UK has now withdrawn from the EU, its rules implementing MiFID II continue to have effect and MiFIR has been on-shored into UK law (subject to certain amendments to ensure it operates properly in a UK-specific context) in connection with this withdrawal.
The UK is introducing a new prudential regulatory framework for UK investment firms (the “Investment Firm Prudential Regime” or “IFPR”), which will be closely based on an equivalent regulatory framework being introduced at EU level through the EU Investment Firm Regulation and Investment Firm Directive. IFPR is expected to take effect from January 1, 2022 and will apply to Ares Management Limited and Ares European Loan Management LLP as U.K. MiFID investment firms. The extent to which the IFPR will apply to Ares Management UK Limited, as a U.K. AIFM with a MiFID “top-up” permission, is as yet unclear and further clarity on this point is expected to emerge in future FCA consultations on the new regime. This new prudential regime is expected to result in higher regulatory capital requirements for some affected firms and new, more onerous remuneration rules, as well as re-cut and extended internal governance, disclosure, reporting, liquidity, and group “prudential” consolidation requirements (among other things).
Our operations and our investment activities worldwide are subject to a variety of regulatory regimes that vary by country. These include Ares SSG Capital Management Limited, which is subject to regulation by various regulatory authorities, including the Securities and Futures Commission of Hong Kong and Monetary Authority of Singapore. In addition, as the ultimate parent of the controlling entity of Aspida Life Re Ltd, a Bermuda Class E insurance company, we are considered its “shareholder controller” (as defined in the Bermuda Insurance Act) by the Bermuda Monetary Authority.
Competition
The investment management industry is intensely competitive, and we expect it to remain so. We compete globally and on a regional, industry and asset basis.
We face competition both in the pursuit of fund investors and investment opportunities. Generally, our competition varies across business lines, geographies and financial markets. We compete for outside investors based on a variety of factors, including investment performance, investor perception of investment managers’ drive, focus and alignment of interest, quality of service provided to and duration of relationship with investors, breadth of our product offering, business reputation and the level of fees and expenses charged for services. We compete for investment opportunities both at our funds and for strategic acquisitions by us based on a variety of factors, including breadth of market coverage and relationships, access to capital, transaction execution skills, the range of products and services offered, innovation and price, and we expect that competition will continue to increase.
We expect to face competition in our direct lending, trading, acquisitions and other investment activities primarily from business development companies, credit and real estate funds, specialized funds, hedge fund sponsors, financial institutions, private equity funds, corporate buyers and other parties. Many of these competitors in some of our businesses are substantially larger and have considerably greater financial, technical and marketing resources than are available to us. Many of these competitors have similar investment objectives to us, which may create additional competition for investment opportunities. Some of these competitors may also have a lower cost of capital and access to funding sources that are not available to us, which may create competitive disadvantages for us with respect to investment opportunities. In addition, some of these competitors may have higher risk tolerances, different risk assessments or lower return thresholds, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we want to make. Corporate buyers may be able to achieve synergistic cost savings with regard to an investment that may provide them with a competitive advantage in bidding for an investment. Lastly, institutional and individual investors are allocating increasing amounts of capital to alternative investment strategies. Several large institutional investors have announced a desire to consolidate their investments in a more limited number of managers. We expect that this will cause competition in our industry to intensify and could lead to a reduction in the size and duration of pricing inefficiencies that many of our funds seek to exploit.
Competition is also intense for the attraction and retention of qualified employees. Our ability to continue to compete effectively in our businesses will depend upon our ability to attract new employees and retain and motivate our existing employees.
For additional information concerning the competitive risks that we face, see “Item 1A. Risk Factors—Risks Related to Our Businesses—The investment management business is intensely competitive.”
Available Information
Ares Management Corporation is a Delaware corporation. Our principal executive offices are located at 2000 Avenue of the Stars, 12th Floor, Los Angeles, California 90067, and our telephone number is (310) 201-4100.
Our website address is http://www.aresmgmt.com. Information on our website is not a part of this report and is not incorporated by reference herein. We make available free of charge on our website or provide a link on our website to our business.Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after those reports are electronically filed with, or furnished to, the SEC. To access these filings, go to the “Investor Resources” section of our website and then click on “SEC Filings.” In addition, these reports and the other documents we file with the SEC are available at a website maintained by the SEC at http://www.sec.gov.
Item 1A. Risk Factors
Risk Factor Summary
Our businesses are subject to a number of inherent risks. We believe that the primary risks affecting our businesses and an investment in shares of our Class A common stock:
•we are subject to risks related to COVID-19 and measures taken to mitigate its impact and spread, which have affected and may continue to affect various aspects of our and our funds’ businesses;
•challenging market and political conditions in the United States and globally may reduce the value or hamper the performance of the investments made by us and our funds or impair the ability of our funds to raise or deploy capital;
•we operate in a complex regulatory and tax environment involving rules and regulations (both domestic and foreign), some of which are outdated relative to today’s global financial activities and some of which are subject to political influence, which could restrict or require us to adjust our operations or the operations of our funds or portfolio companies and subject us to increased compliance costs and administrative burdens, as well as restrictions on our business activities;
•if we are unable to raise capital from investors or deploy capital into investments, or if any of our management fees are waived or reduced, or if we fail to generate performance income, our revenues and cash flows would be materially reduced;
•we are subject to risks related to our dependency on our members of the Executive Management Committee, senior professionals and other key personnel as well as attracting and retaining and developing human capital in a highly competitive talent market;
•we may experience reputational harm if we fail to appropriately address conflicts of interest or if we, our employees, our funds or our portfolio companies fail (or are alleged to have failed) to comply with applicable regulations in an increasingly complex political and regulatory environment;
•we face intense competition in the investment management business;
•our growth strategy contemplates acquisitions and entering new lines of business and expanding into new investment strategies, geographic markets and businesses, which subject us to numerous risks, expenses and uncertainties, including related to the integration of development opportunities, acquisitions or joint ventures;
•we derive a significant portion of our management fees from ARCC;
•economic U.S. and foreign sanction laws may prohibit us and our affiliates from transacting with certain countries, individuals and companies;
•our international operations subject us to numerous regulatory and operational risks and expenses;
•we are subject to operational risks and risks in using prime brokers, custodians, counterparties, administrators and other agents;
•the increasing demands of fund investors, including the potential for fee compression and changes to other terms, could materially adversely affect our future revenues;
•we may be subject to cybersecurity risks and changes to data protection regulation;
•we may be subject to litigation risks and related liabilities or risks related employee misconduct, fraud and other deceptive practices;
•the use of leverage by us and our funds exposes us to substantial risks, including related to changes to the method of determining LIBOR or the selection of a replacement for LIBOR;
•asset valuation methodologies can be highly subjective and the value of assets may not be realized;
•our funds may perform poorly due to market conditions, political actions or environments, monetary and fiscal policy or other conditions beyond our control;
•third-party investors in our funds may not satisfy their contractual obligation to fund capital calls;
•we are subject to risks relating to our contractual rights and obligations under our funds’ governing documents and investment management agreements;
•a downturn in the global credit markets could adversely affect our CLO investments;
•due to our and our funds’ investments in certain market sectors, such as power, infrastructure and energy, real estate and insurance, we are subject to risks and regulations inherent to those industries;
•if we were deemed to be an “investment company” under the Investment Company Act, applicable restrictions could make it impractical for us to continue our businesses as contemplated;
•due to the Holdco Members ownership and control of our shares of common stock, holders of our Class A common stock will generally have no influence over matters on which holders of our common stock vote and limited ability to influence decisions regarding our business;
•we are subject to risks related to our categorization as a “controlled company” within the meaning of the NYSE listing standards;
•potential conflicts of interest may arise among the holders of Class B and Class C common stock and the holders of our Class A common stock and preferred stock;
•our holding company structure, Delaware law and contractual restrictions may limit our ability to pay dividend to the holders of our Class A common stock and our dividends are non-cumulative;
•other anti-takeover provisions in our charter documents could delay or prevent a change in control;
•we are subject to risks related to our tax receivable agreement; and
•limitations on the amount of interest expense that we may deduct could materially increase our tax liability and negatively affect an investment in shares of our Class A common stock.
Risks Related to Our Businesses
The COVID-19 pandemic has caused severe disruptions in the U.S. and global economy, has disrupted, and may continue to disrupt, industries in which we, our funds and our funds’ portfolio companies operate and could potentially negatively impact us, our funds or our funds’ portfolio companies.
Over the past year, the COVID-19 pandemic has resulted in a global and national health crisis, adversely impacted global commercial activity and contributed to significant volatility in equity and debt markets. Many countries and states in the United States, including those in which we, our funds’ and our funds’ portfolio companies operate, issued (and continue to re-issue) orders requiring the closure of, or certain restrictions on the operation of, nonessential businesses and/or requiring residents to stay at home. The COVID-19 pandemic and preventative measures taken to contain or mitigate its spread have caused, and are continuing to cause, business shutdowns or the re-introduction of business shutdowns, cancellations of events and restrictions on travel, significant reductions in demand for certain goods and services, reductions in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability both globally and in the United States. Such measures, as well as the general uncertainty surrounding the dangers and impact of the COVID-19 pandemic, have created significant disruption in supply chains and economic activity and have had a particularly adverse impact on the energy, hospitality, travel, retail and restaurant industries, as well as other industries, including industries in which certain of our funds’ portfolio companies operate. Such effects will likely continue for the duration of the pandemic, which is uncertain, and for some period thereafter. While several countries, as well as certain states, counties and cities in the United States, relaxed the early public health restrictions with a view to partially or fully reopening their economies, many cities, both globally and in the United States, have since experienced a surge in the reported number of cases and hospitalizations related to the COVID-19 pandemic. This increase in cases has led to the re-introduction of such restrictions and business shutdowns in certain states, counties and cities in the United States and globally and could lead to the re-introduction of such restrictions elsewhere. In December 2020, the Federal Food and Drug Administration authorized COVID‑19 vaccines and the distribution of such vaccines has commenced. However, it remains unclear how quickly the vaccines will be distributed nationwide and globally or when “herd immunity” will be achieved and whether the restrictions that were imposed to slow the spread of the virus will be lifted entirely. Ongoing restrictions and any delay in distributing the vaccines could lead people to continue to self-isolate and not participate in the economy at pre-pandemic levels for a prolonged period of time. Even after the COVID-19 pandemic subsides, the U.S. economy and most other major global economies may continue to experience a recession, and we anticipate our and our funds’ business and operations, as well as the business and operations of our funds’ portfolio companies, could be materially adversely affected by a prolonged recession in the U.S. and other major markets.
The extent of the impact of the COVID-19 pandemic (including the restrictive measure taken in response thereto) on our and our funds’ operational and financial performance will depend on many factors, including the duration, severity and scope of the public health emergency, the actions taken by governmental authorities to contain its financial and economic impact, the continued implementation of travel advisories and restrictions, the impact of such public health emergency on overall supply and demand, goods and services, investor liquidity, consumer confidence and levels of economic activity and the extent of its disruption to global, regional and local supply chains and economic markets, all of which are uncertain and difficult to assess. The COVID-19 pandemic is continuing as of the filing date of this Annual Report and its extended duration may have further adverse impacts on our business, financial performance, operating results, cash flows and financial condition, including the market price of shares of our securities, including for the reasons described below.
The effects of a public health crisis such as the COVID-19 pandemic may materially and adversely impact our value and performance and the value and performance of our funds and our funds’ portfolio companies. Further, the impact of the COVID-19 pandemic may not be fully reflected in the valuation of our or our funds’ investments, which may differ materially from the values that we may ultimately realize with respect to such investments. Our valuations, and particularly valuations of our interests in our funds and our funds’ investments, reflect a moment in time, are inherently uncertain, may fluctuate over short periods of time and are often based on subjective estimates, comparisons and qualitative evaluations of private information. Valuations, on an unrealized basis, can also be significantly affected by a variety of external factors including, but not limited to, public equity market volatility, industry trading multiples and interest rates, all of which have been impacted and continue to be impacted by the COVID-19 pandemic. Further, the extreme volatility in the broader market and particularly in the energy markets has led to a broad decrease in valuations and such valuations may continue to decline and become increasingly difficult to ascertain. As a result, our valuations and the valuations of our interests in our funds and our funds’ investments, may not show the complete or continuing impact of the COVID-19 pandemic and the resulting measures taken in response thereto. Accordingly, we and our funds may continue to incur additional net unrealized losses or may incur realized losses in the future, which could have a material adverse effect on our business, financial condition and results of operations. Any public health emergency, including the COVID-19 pandemic or any outbreak of other existing or new epidemic diseases, or the threat thereof, and the resulting financial and economic market uncertainty could have a significant adverse impact on us,
the fair value of our and our funds’ investments and could adversely impact our funds’ ability to fulfill our investment objectives.
Our ability to market and raise new or successor funds in the future may be impacted by the continuation and reintroduction of shelter-in-place orders, travel restrictions and social distancing requirements implemented in response to the COVID-19 pandemic. This may reduce or delay anticipated fee revenues. In addition, the significant volatility and declines in valuations in the global markets as well as liquidity concerns may impact our ability to raise funds or deter fund investors from investing in new or successor funds that we are marketing.
Our funds may experience a slowdown in the pace of their investment activity and capital deployment, which could also adversely affect the timing of raising capital for new or successor funds and could also impact the management fees we earn on funds that generate fees based on invested (and not committed) capital. While the increased volatility in the financial markets caused by the COVID-19 pandemic may present attractive investment opportunities, we or our funds may not be able to complete those investments due to, among other factors, increased competition or operational challenges such as our ability to obtain attractive financing, conduct due diligence and consummate the acquisition and disposition of investments for our funds because of continued and re-introduced shelter-in-place orders, travel restrictions and social distancing requirements.
If the impact of the COVID-19 pandemic and current market conditions continue, we and our funds may have fewer opportunities to successfully exit investments, due to, among other reasons, lower valuations, decreased revenues and earnings, lack of potential buyers with financial resources or access to financing to pursue an acquisition, lack of refinancing markets, resulting in a reduced ability to realize value from such investments at attractive valuations or at all, and thereby negatively impacting our realized income.
Adverse market conditions resulting from the COVID-19 pandemicmay impact our liquidity. Our cash flows from management fees may be impacted by, among other things, a slowdown in fundraising or delayed deployment. Cash payment of adverse market conditions may make it difficult for us to refinance our existing indebtedness or obtain new indebtedness with similar terms and any failure to do so could have a material adverse effect on our business. The capital that will be available to us in the future, if at all, may be at a higher cost and on less favorable terms and conditions than we currently experience. While our senior professionals have historically made co-investments in our funds alongside our limited partners, thereby reducing our obligation to make such investments, due to financial uncertainty or liquidity concerns, our employees may be less likely to make co-investments, which would result in such general partner commitments remaining our obligation to fund and reducing our liquidity. In addition, our funds may be impacted due to failure by our fund investors to meet capital calls, which would negatively impact our funds’ ability to make investments or pay us management fees.
The COVID-19 pandemic is having a particularly severe impact on certain industries, including but not limited to the energy, hospitality, travel, retail and restaurant industries, which are industries in which some of our funds have made investments. Many of our funds’ portfolio companies in these industries have faced and are continuing to face operational and financial challenges resulting from the spread of COVID-19 and related governmental measures, such as the closure of stores, hotels, restaurants and other locations, restrictions on travel, quarantines or continued and re-introduced stay-at-home orders. As a result of these disruptions, the businesses, financial results and prospects of certain of these portfolio companies have already been severely affected and could continue to be so affected. This has caused and may in the future result in impairment and decrease in value of our funds’ investments, which may be material.
Our funds’ portfolio companies are also facing or may face in the future increased credit and liquidity risk due to volatility in financial markets, reduced or eliminated revenue streams, and limited or higher cost of access to preferred sources of funding. Changes in the debt financing markets are impacting, and, if the volatility in financial markets continues, may in the future impact, the ability of our funds’ portfolio companies to meet their respective financial obligations and continue as going concerns. This could lead to the insolvency and/or bankruptcy of these companies which would cause our funds to realize losses in respect of those investments. Any of the foregoing would adversely affect our results of operations, perhaps materially, and could harm our reputation.
Our funds may experience similar credit and liquidity risk. Failure of our funds to meet their financial obligations could result in our funds being required to repay indebtedness or other financial obligations immediately in whole or in part, together with any attendant costs, and our funds could be forced to sell some of their assets to fund such costs. Our funds could lose both invested capital in, and anticipated profits from, the affected investment.
Borrowers of loans and other credit instruments made by our funds may be unable to make their loan payments on a timely basis and meet their loan covenants, and tenants leasing real estate properties owned by our funds may not be able to pay rents in a timely manner or at all, resulting in a decrease in value of our funds’ credit and real estate investments and lower than
expected returns. In addition, for variable interest instruments, lower reference rates resulting from government stimulus programs in response to the COVID-19 pandemic could lead to lower interest income for funds making loans.
The COVID-19 pandemic may adversely impact our business and operations since an extended period of remote working by our employees could strain our technology resources and introduce operational risks, including heightened cybersecurity risk. While we have taken steps to secure our networks and systems, remote working environments may be less secure and more susceptible to hacking attacks, including phishing and social engineering attempts that seek to exploit the COVID-19 pandemic. In addition, our data security, data privacy, investor reporting and business continuity processes could be impacted by a third party’s inability to perform due to the COVID-19 pandemic or by failures of, or attacks on, their information systems and technology. Also, our accounting and financial reporting systems, processes, and controls could be impacted as a result of these risks. In addition, COVID-19 presents a significant threat to our employees’ well-being and morale, and we may experience potential loss of productivity. If our senior management or other key personnel become ill or are otherwise unable to perform their duties for an extended period of time, we may experience a loss of productivity or a delay in the implementation of certain strategic plans. In addition to any potential impact of such extended illness on our operations, we may be exposed to the risk of litigation by our employees against us for, among other things, failure to take adequate steps to protect their well-being, particularly in the event they become sick after a return to the office. Further, local COVID-19-related laws can be subject to rapid change depending on public health developments, which can lead to confusion and make compliance with laws uncertain and subject us, our funds or our funds’ portfolio companies to increased risk of litigation for non-compliance.
Additionally, due to stay-at-home orders, travel restrictions, and other COVID-19 related responses, many of our staff cannot travel for in-person meetings and/or have been working remotely outside of their usual work location. This could create taxable presence or residency risks for our corporate entities, professionals, funds and portfolio companies, which risks could lead to increased tax liability and additional compliance complexities.
Regulatory oversight and enforcement may become more rigorous for the financial services industry and other regulated industries as a result of the impact of the COVID-19 pandemic on the financial markets, especially in the wake of the array of governmental financial assistance programs provided by state and national governments around the world. In addition, new laws or regulations that are passed in response to the COVID-19 pandemic could adversely impact investment management firms. This may result in a more complex regulatory, tax and political environment, which could subject us to increased compliance costs and administrative burdens.
Difficult market and political conditions may adversely affect our businesses in many ways, including by reducing the value or hampering the performance of the investments made by our funds or reducing the ability of our funds to raise or deploy capital, each of which could materially reduce our revenue, earnings and cash flow and adversely affect our financial prospects and condition.
Our businesses are materially affected by conditions in the global financial markets and economic and political conditions throughout the world, such as interest rates, the availability and cost of credit, inflation rates, economic uncertainty, changes in laws (including laws relating to our taxation, taxation of our investors and the possibility of changes to regulations applicable to alternative asset managers), trade policies, commodity prices, tariffs, currency exchange rates and controls and national and international political circumstances (including wars and other forms of conflict, terrorist acts, and security operations) and catastrophic events such as fires, floods, earthquakes, tornadoes, hurricanes, other adverse weather and climate conditions and pandemics. These factors are outside of our control and may affect the level and volatility of securities prices and the liquidity and value of investments, and we may not be able to or may choose not to manage our exposure to these conditions.
Global financial markets have experienced heightened volatility in recent periods, including as a result of economic and political events in or affecting the world’s major economies. For example, the withdrawal of the U.K. from the EU in January 2020 and subsequent ongoing uncertainty regarding the future relationship between the U.K. and the EU following the end of the Brexit transition period on December 31, 2020, hostilities in the Middle East region, recent U.S. presidential and congressional elections and resulting uncertainties regarding actual and potential shifts in U.S. and foreign, trade, economic and other policies, and concerns over increasing inflation and deflation, as well as interest rate volatility and fluctuations in oil and gas prices resulting from global production and demand levels, have precipitated market volatility.
In addition, numerous structural dynamics and persistent market trends have exacerbated volatility generally. Concerns over significant declines in the commodities markets, sluggish economic expansion in non-U.S. economies, including continued concerns over growth prospects in China and emerging markets, growing debt loads for certain countries and uncertainty about the consequences of the U.S. and other governments withdrawing monetary stimulus measures all highlight the fact that economic conditions remain unpredictable and volatile. In recent periods, trade tensions between the U.S. and China have
escalated. Further escalation of trade tensions between the U.S. and China, or the countries’ inability to reach a timely trade agreement, may negatively impact the rate of global growth, particularly in China, which has and continues to exhibit signs of slowing growth. Moreover, there is a risk of both sector-specific and broad-based corrections and/or downturns in the equity and credit markets. Any of the foregoing could have a significant impact on the markets in which we operate and a material adverse impact on our business prospects and financial condition.
A number of factors have had and may continue to have an adverse impact on credit markets in particular. The weakness and the uncertainty regarding the stability of the oil and gas markets resulted in a tightening of credit across multiple sectors. In addition, although the Federal Reserve has recently lowered the federal funds rate following a period of numerous increases, changes in and uncertainty surrounding interest rates may have a material effect on our business, particularly with respect to the cost and availability of financing for significant acquisition and disposition transactions. Moreover, while conditions in the U.S. economy have generally improved since the credit crisis, many other economies continue to experience weakness, tighter credit conditions and a decreased availability of foreign capital. Since credit represents a significant portion of our business and ongoing strategy, any of the foregoing could have a material adverse impact on our business prospects and financial condition.
These and other conditions in the global financial markets and the global economy may result in adverse consequences for us and many of our funds, each of which could adversely affect the business of such funds, restrict such funds’ investment activities, impede such funds’ ability to effectively achieve their investment objectives and result in lower returns than we anticipated at the time certain of our investments were made. More specifically, these economic conditions could adversely affect our operating results by causing:
•decreases in the market value of securities, debt instruments or investments held by some of our funds;
•illiquidity in the market, which could adversely affect transaction volumes and the pace of realization of our funds’ investments or otherwise restrict the ability of our funds to realize value from their investments, thereby adversely affecting our ability to generate performance or other income;
•our assets under management to decrease, thereby lowering a portion of our management fees payable by our funds to the extent they are based on market values; and
•increases in costs or reduced availability of financial instruments that finance our funds.
During periods of difficult market conditions or slowdowns (which may be across one or more industries, sectors or geographies), companies in which we invest may experience decreased revenues, financial losses, credit rating downgrades, difficulty in obtaining access to financing and increased funding costs. During such periods, these companies may also have difficulty in expanding their businesses and operations and be unable to meet their debt service obligations or other expenses as they become due, including expenses payable to us. Negative financial results in our funds’ portfolio companies may reduce the value of our portfolio companies, the net asset value of our funds and the investment returns for our funds, which could have a material adverse effect on our operating results and cash flow. In addition, such conditions would increase the risk of default with respect to credit-oriented or debt investments. Our funds may be adversely affected by reduced opportunities to exit and realize value from their investments, by lower than expected returns on investments made prior to the deterioration of the credit markets and by our inability to find suitable investments for the funds to effectively deploy capital, which could adversely affect our ability to raise new funds and thus adversely impact our prospects for future growth.
Political and regulatory conditions, including the effects of negative publicity surrounding the financial industry in general and proposed legislation, could adversely affect our businesses.
As a result of market disruptions and highly publicized financial scandals in recent years, regulators and investors have exhibited concerns over the integrity of the U.S. financial markets. The businesses that we operate both in and outside the United States will be subject to new or additional regulations. We may be adversely affected as a result of new or revised legislation or regulations imposed by the SEC, the CFTC, FINRA or other U.S. or non-U.S. governmental regulatory authorities or self-regulatory organizations that supervise the financial markets. We may also be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental authorities and self-regulatory organizations.
Throughout 2020 and continuing into 2021 there has been an increasing level of public discourse, debate and media coverage regarding the appropriate extent of regulation and oversight of the financial industry, including investment firms, as well as the tax treatment of certain investments and income generated from such investments. For further discussion regarding recent legislation affecting the taxation of carried interest, see “-We depend on the members of the Executive Management Committee, senior professionals and other key personnel, and our ability to retain them and attract additional qualified personnel is critical to our success and our growth prospects.” In connection with the 2020 U.S. presidential and Congressional
elections and the transition to a Democratic Presidential administration and majority in the U.S. Congress, uncertainty has arisen regarding prospective changes in law and regulation affecting the U.S. private equity industry, including the possibility of significant revision to the Code and U.S. financial laws, rules and regulations. The likelihood of occurrence and the effect of any such change is highly uncertain and could have an adverse impact on us, our portfolio companies and our fund investors. See “Risk Related to Regulation-Extensive regulation affects our activities, increases the cost of doing business and creates the potential for significant liabilities and penalties that could adversely affect our businesses and results of operations.”
Changes in relevant tax laws, regulations or treaties or an adverse interpretation of these items by tax authorities may adversely affect our effective tax rate, tax liability and financial condition and results.
Any substantial changes in domestic or international corporate tax policies, regulations or guidance, enforcement activities or legislative initiatives may adversely affect our business, the amount of taxes we are required to pay and our financial condition and results of operations generally. Our effective tax rate and tax liability is based on the application of current income tax laws, regulations and treaties. These laws, regulations and treaties are complex, and the manner which they apply to us and our funds is sometimes open to interpretation. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. Although management believes its application of current laws, regulations and treaties to be correct and sustainable upon examination by the tax authorities, the tax authorities could challenge our interpretation resulting in additional tax liability or adjustment to our income tax provision that could increase our effective tax rate. For an overview of certain relevant U.S. tax laws and relevant foreign tax laws (and FATCA), see “-Risks Related to Taxation-Applicable U.S. and foreign tax law, regulations, or treaties, and changes in such tax laws, regulations or treaties or an adverse interpretation of these items by tax authorities could adversely affect our effective tax rate, tax liability, financial condition and results, ability to raise funds from certain foreign investors, increase our compliance or withholding tax costs and conflict with our contractual obligations.”
Our business depends in large part on our ability to raise capital from investors. If we were unable to raise such capital, we would be unable to collect management fees or deploy such capital into investments, which would materially reduce our revenues and cash flow and adversely affect our financial condition.
Our ability to raise capital from investors depends on a number of factors, including many that are outside our control. Investors may downsize their investment allocations to alternative asset managers to rebalance a disproportionate weighting of their overall investment portfolio among asset classes. If the value of an investor’s portfolio decreases as a whole, the amount available to allocate to alternative investments could decline. Further, investors often evaluate the amount of distributions they have received from existing funds when considering commitments to new funds. Poor performance of our funds, or regulatory or tax constraints, could also make it more difficult for us to raise new capital. Our investors and potential investors continually assess our funds’ performance independently and relative to market benchmarks and our competitors, which affects our ability to raise capital for existing and future funds. If economic and market conditions deteriorate or continue to be volatile, investors may delay making new commitments to investment funds and/or we may be unable to raise sufficient amounts of capital to support the investment activities of future funds. We may not be able to find suitable investments for the funds to effectively deploy capital, which could adversely affect our ability to raise new funds and our prospects for future growth. This may be particularly impactful for our larger flagship funds. In addition, certain investors have implemented or may implement restrictions against investing in certain types of asset classes, such as fossil fuels, which would affect our ability to raise new funds focused on those asset classes. If we were unable to successfully raise capital, our revenue and cash flow would be reduced, and our financial condition would be adversely affected. Furthermore, while our senior professionals have committed substantial capital to our funds, commitments from new investors may depend on the commitments made by our senior professionals to new funds and there can be no assurance that there will be further commitments to our funds by these individuals, and any future investments by them in our funds or other alternative investment categories will likely depend on the performance of our funds, the performance of their overall investment portfolios and other investment opportunities available to them.
We depend on the members of the Executive Management Committee, senior professionals and other key personnel, and our ability to retain them and attract additional qualified personnel is critical to our success and our growth prospects.
We depend on the diligence, skill, judgment, business contacts and personal reputations of the members of the Executive Management Committee, senior professionals and other key personnel. Our future success will depend upon our ability to retain our senior professionals and other key personnel and our ability to recruit additional qualified personnel. These individuals possess substantial experience and expertise in investing, are responsible for locating and executing our funds’ investments, have significant relationships with the institutions that are the source of many of our funds’ investment opportunities and, in certain cases, have strong relationships with our investors. Therefore, if any of our senior professionals or other key personnel join competitors or form competing companies, it could result in the loss of significant investment opportunities, limit our ability to raise capital from certain existing investors or result in the loss of certain existing investors.
The departure or bad acts of any of our senior professionals, or a significant number of our other investment professionals, could have a material adverse effect on our ability to achieve our investment objectives, cause certain of our investors to withdraw capital they invest with us or elect not to commit additional capital to our funds or otherwise have a material adverse effect on our business and our prospects. Turnover and associated costs of rehiring, the loss of human capital through attrition and the reduced ability to attract talent could impair our ability to implement our growth strategy and maintain our standards of excellence. Further the departure of some or all of those individuals could also trigger certain “key person” provisions in the documentation governing certain of our funds, which would permit the investors in those funds to suspend or terminate such funds’ investment periods or, in the case of certain funds, permit investors to withdraw their capital prior to expiration of the applicable lock-up date. We do not carry any “key person” insurance that would provide us with proceeds in the event of the death or disability of any of our senior professionals, and we do not have a policy that prohibits our senior professionals from traveling together. See “-Employee misconduct could harm us by impairing our ability to attract and retain investors and subjecting us to significant legal liability, regulatory scrutiny and reputational harm.”
We anticipate that it will be necessary for us to add investment professionals both to grow our businesses and to replace those who depart. Competition for qualified, motivated, and highly-skilled executives, professionals and other key personnel in investment management firms is significant, both in the United States and internationally, and we may not succeed in recruiting additional personnel or we may fail to effectively replace current personnel who depart with qualified or effective successors. We seek to offer our personnel meaningful professional development opportunities and programs such as employee engagement, training and development opportunities and periodic review processes. We also seek to provide our personnel with competitive benefits and compensation packages. However, these efforts may not be sufficient to enable us to attract, retain and motivate qualified individuals to support our growth.
Furthermore, under the Tax Cuts and Jobs Act, investments must be held for more than three years, rather than the prior requirement of more than one year, for carried interest to be treated for U.S. federal income tax purposes as capital gain. The longer holding period requirement may result in some or all of our carried interest being treated as ordinary income, which would materially increase the amount of taxes that our employees and other key personnel would be required to pay. In January 2021, the IRS released final regulations (which generally retain the basic approach and structure of the proposed regulations published in August 2020, with certain significant revisions) implementing the carried interest provisions that were enacted as part of the Tax Cuts and Jobs Act. We are currently evaluating the potential tax impacts of such regulations, and the ultimate tax consequences of such regulations are uncertain. Although most proposals regarding the taxation of carried interest still require gain realization before applying ordinary income rates, legislation has been introduced that would assume a deemed annual return on carried interest and tax that amount annually, with a true-up once the assets are sold. In addition, following the Tax Cuts and Jobs Act, the tax treatment of carried interest has continued to be an area of focus for policymakers and government officials, which could result in a further regulatory action by federal or state governments. For example, certain states, including New York and California, have proposed legislation to levy additional state tax on carried interest. Tax authorities and legislators in other jurisdictions that Ares has investments or employees in could clarify, modify or challenge their treatment of carried interest. For example, the UK Office of Tax Simplification is currently reviewing the UK Capital Gains Tax Regime, and there is a risk that such review could result in a change to the taxation of carried interest with respect to our UK investment professionals. Additionally, the COVID-19 pandemic may increase these risks as international authorities consider methods to increase tax revenues due to increasing fiscal deficits. In addition, there have been proposed laws and regulations that sought to regulate the compensation of certain of our employees. All of these changes may materially increase the amount of taxes that our employees and other key personnel would be required to pay and as a result may impact our ability to recruit, retain and motivate employees and key personnel in the relevant jurisdictions or may require us in certain circumstances to consider alternative or modified incentive arrangements for such employees or key personnel. Our efforts to retain and attract investment professionals may also result in significant additional expenses, which could adversely affect our profitability or result in an increase in the portion of our performance income that we grant to our investment professionals. In the year ended December 31, 2020, we incurred equity compensation expenses of $123.0 million, and we expect these costs to continue to increase in the future as we increase the use of equity compensation awards to attract, retain and compensate employees.
Our failure to appropriately address conflicts of interest could damage our reputation and adversely affect our businesses.
As we have expanded and as we continue to expand the number and scope of our businesses, we increasingly confront potential conflicts of interest relating to our and our funds’ investment activities. These conflicts are most likely to arise between or among our funds or between one or more funds across our Credit, Private Equity, Real Estate and Strategic Initiatives Groups, including any special purpose acquisition companies (“SPACs”) and similar investment vehicles that we sponsor. We and certain of our funds may have overlapping investment objectives, including funds that have different fee structures, and potential conflicts may arise with respect to our decisions regarding how to allocate investment opportunities. For example, a decision to receive material non-public information about a company while pursuing an investment opportunity may give rise to a potential conflict of interest if it results in our having to restrict any fund or other part of our business from
trading in the securities of such company. Further, we may allocate an investment opportunity that is appropriate for Ares and/or multiple funds in a manner that excludes one or more funds or results in a disproportionate allocation based on factors or criteria that we determine, such as differences with respect to available capital, the size of a fund, minimum investment amounts and remaining life of a fund, differences in investment objectives or current investment strategies, such as objectives or strategies, differences in risk profile at the time an opportunity becomes available, the potential transaction and other costs of allocating an opportunity among various funds, potential conflicts of interest, including whether multiple funds have an existing investment in the security in question or the issuer of such security, the nature of the security or the transaction including the size of investment opportunity, minimum investment amounts and the source of the opportunity, current and anticipated market and general economic conditions, existing positions in an issuer/security, prior positions in an issuer/security and other considerations deemed relevant to us. We may also cause one or more funds to invest in a single portfolio company, for example, where the fund that made an initial investment no longer has capital available to invest. We may also cause different funds that we advise to purchase different classes of securities in the same portfolio company. For example, in the normal course of business our Credit Group funds acquire debt positions in companies in which our Private Equity Group funds own common equity securities. A direct conflict of interest could arise between the debt holders and the equity holders if such a company were to develop insolvency concerns. In addition, funds in one group could be restricted from selling their positions in such companies for extended periods because investment professionals in another group sit on the boards of such companies or because another part of the firm has received private information. Certain funds in different groups may invest alongside each other in the same security. ARCC and other business development companies and registered closed-end management investment companies managed by a subsidiary of us are permitted to co-invest in portfolio companies with each other and with affiliated investment funds pursuant to an SEC order (the “Co-investment Exemptive Order”). The different investment objectives or terms of such funds may result in a potential conflict of interest, including in connection with the allocation of investments between the funds made pursuant to the Co-investment Exemptive Order. In addition, conflicts of interest may exist in the valuation of our investments and regarding decisions about the allocation of specific investment opportunities among us and our funds and the allocation of fees and costs among us, our funds and their portfolio companies.
Though we believe we have appropriate means and oversight to resolve these conflicts, our judgment on any particular allocation could be challenged. While we have developed general guidelines regarding when two or more funds can invest in different parts of the same company’s capital structure and created a process that we employ to handle such conflicts if they arise, our decision to permit the investments to occur in the first instance or our judgment on how to minimize the conflict could be challenged. If we fail to appropriately address any such conflicts, it could negatively impact our reputation and ability to raise additional funds and the willingness of counterparties to do business with us or result in potential litigation against us.
Conflicts of interest may arise in our allocation of co-investment opportunities.
As a general matter, our allocation of co-investment opportunities is entirely within our discretion and there can be no assurance that co-investments of any particular type or amount will be allocated to any of our funds or investors. There can be no assurance that co-investments will become available and we will take into account a variety of factors and considerations we deem relevant in our sole discretion in allocating co-investment opportunities, including, without limitation, whether a potential co-investor has expressed an interest in evaluating co-investment opportunities, our assessment of a potential co-investor’s ability to invest an amount of capital that fits the needs of the co-investment and its history of participating in Ares co-investments, the size of the potential co-investor’s commitments to our funds, the length and nature of our relationship with the potential co-investor, including whether the potential co-investor has demonstrated a long-term and/or continuing commitment to the potential success of Ares or any of its funds, whether the co-investor is considered strategic to the co-investment, our assessment of a potential co-investor’s ability to commit to a co-investment opportunity within the required timeframe of the particular transaction, the economic and other terms of such co-investment (e.g., whether management fees and/or carried interest would be payable to us and the extent thereof), and such other factors and considerations that we deem relevant in our sole discretion under the circumstances.
Certain funds in different groups may invest alongside each other in the same security. ARCC and other business development companies and registered closed-end management investment companies managed by a subsidiary of us are permitted to co-invest in portfolio companies with each other and with affiliated investment funds pursuant to the Co-investment Exemptive Order. The different investment objectives or terms of such funds may result in a potential conflict of interest, including in connection with the allocation of investments between the funds made pursuant to the Co-investment Exemptive Order. In addition, conflicts of interest may exist in the valuation of our investments and regarding decisions about the allocation of specific investment opportunities among us and our funds and the allocation of fees and costs among us, our funds and their portfolio companies. We, from time to time, incur fees, costs, and expenses on behalf of more than one fund. To the extent such fees, costs, and expenses are incurred for the account or benefit of more than one fund, each such fund will typically bear an allocable portion of any such fees, costs, and expenses in proportion to the size of its investment in the activity or entity to which such expense relates (subject to the terms of each fund’s governing documents) or in such other manner as we considers fair and equitable under the circumstances such as the relative fund size or capital available to be invested by such
funds. Where a fund’s governing documents do not permit the payment of a particular expense, we will generally pay such fund’s allocable portion of such expense.
Potential conflicts will arise with respect to our decisions regarding how to allocate co-investment opportunities among our funds and investors and the terms of any such co-investments. Our fund documents typically do not mandate specific allocations with respect to co-investments. The investment advisers of our funds may have an incentive to provide co-investment opportunities to certain investors in lieu of others. Co-investment arrangements may be structured through one or more of our investment vehicles, and in such circumstances, co-investors will generally bear the costs and expenses thereof (which may lead to conflicts of interest regarding the allocation of costs and expenses between such co-investors and investors in our other investment funds). The terms of any such existing and future co-investment vehicles may differ materially, and in some instances may be more favorable to us, than the terms of certain of our funds or prior co-investment vehicles, and such different terms may create an incentive for us to allocate a greater or lesser percentage of an investment opportunity to such funds or such co-investment vehicles, as the case may be. Such incentives will from time to time give rise to conflicts of interest. There can be no assurance that any conflicts of interest will be resolved in favor of any particular investment funds or investors (including any applicable co-investors) and there is a risk that such investment fund or investor (or the SEC) may challenge our treatment of such conflict, which could impose costs on our business and expose us to potential liability.
The investment management business is intensely competitive.
The investment management business is intensely competitive, with competition based on a variety of factors, including investment performance, business relationships, quality of service provided to investors, investor liquidity and willingness to invest, fund terms (including fees), brand recognition and business reputation. We compete with a number of private equity funds, specialized funds, hedge funds, corporate buyers, traditional asset managers, real estate development companies, commercial banks, investment banks, other investment managers and other financial institutions, as well as domestic and international pension funds and sovereign wealth funds, and we expect that competition will continue to increase.
Numerous factors increase our competitive risks, including, but not limited to:
•a number of our competitors in some of our businesses have greater financial, technical, marketing and other resources and more personnel than we do;
•some of our funds may not perform as well as competitors’ funds or other available investment products;
•several of our competitors have raised significant amounts of capital, and many of them have similar investment objectives to ours, which may create additional competition for investment opportunities;
•some of our competitors may have a lower cost of capital and access to funding sources that are not available to us, which may create competitive disadvantages for us with respect to our funds, particularly our funds that directly use leverage or rely on debt financing of their portfolio investments to generate superior investment returns;
•some of our competitors may have higher risk tolerances, different risk assessments or lower return thresholds than us, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we want to make;
•some of our competitors may be subject to less regulation and, accordingly, may have more flexibility to undertake and execute certain businesses or investments than we do and/or bear less compliance expense than we do;
•some of our competitors may not have the same types of conflicts of interest as we do;
•some of our competitors may have more flexibility than us in raising certain types of funds under the investment management contracts they have negotiated with their investors;
•some of our competitors may have better expertise or be regarded by investors as having better expertise in a specific asset class or geographic region than we do;
•our competitors that are corporate buyers may be able to achieve synergistic cost savings in respect of an investment, which may provide them with a competitive advantage in bidding for an investment;
•our competitors have instituted or may institute low cost high speed financial applications and services based on artificial intelligence and new competitors may enter the asset management space using new investment platforms based on artificial intelligence; and
•other industry participants may, from time to time, seek to recruit our investment professionals and other employees away from us.
Developments in financial technology, such as a distributed ledger technology (or blockchain), have the potential to disrupt the financial industry and change the way financial institutions, including investment managers, do business, and could exacerbate these competitive pressures.
We may lose investment opportunities in the future if we do not match pricing, structures and terms offered by our competitors. Alternatively, we may experience decreased profitability, rates of return and increased risks of loss if we match pricing, structures and terms offered by our competitors.
In addition, the attractiveness of investments in our funds relative to other investment products could decrease depending on economic conditions. This competitive pressure could adversely affect our ability to make successful investments and limit our ability to raise future funds, either of which would adversely impact our businesses, revenues, results of operations and cash flow.
Lastly, institutional and individual investors are allocating increasing amounts of capital to alternative investment strategies. Several large institutional investors have announced a desire to consolidate their investments in a more limited number of managers. We expect that this will cause competition in our industry to intensify and could lead to a reduction in the size and duration of pricing inefficiencies that many of our funds seek to exploit.
Poor performance of our funds would cause a decline in our revenue and results of operations, may obligate us to repay performance income previously paid to us and could adversely affect our ability to raise capital for future funds.
We derive revenues primarily from:
•management fees, which are based generally on the amount of capital committed to or invested by our funds;
•performance income, which are based on the performance of our funds; and
•returns on investments of our own capital in the funds and other investment vehicles, including SPACs, that we sponsor and manage.
When any of our funds perform poorly, either by incurring losses or underperforming benchmarks, as compared to our competitors or otherwise, our investment record suffers. As a result, our performance income may be adversely affected and, all else being equal, the value of our assets under management could decrease, which may, in turn, reduce our management fees. Moreover, we may experience losses on investments of our own capital as a result of poor investment performance. If a fund performs poorly, we will receive little or no performance income with regard to the fund and little income or possibly losses from our own principal investment in such fund. Furthermore, if, as a result of poor performance or otherwise, a fund does not achieve total investment returns that exceed a specified investment return threshold over the life of the fund or other measurement period, we may be obligated to repay the amount by which performance income that were previously distributed or paid to us exceeds amounts to which we were entitled. Poor performance of our funds and other vehicles could also make it more difficult for us to raise new capital. Investors in our closed-end funds may decline to invest in future closed-end funds we raise as a result of poor performance. Investors in our open-ended funds may redeem their investment as a result of poor performance. Poor performance of our publicly traded funds may result in stockholders selling their stock in such vehicles, thereby causing a decline in the stock price and limiting our ability to access capital. For further information on the impact of poor fund performance, see “We may not be able to maintain our current fee structure as a result of industry pressure from fund investors to reduce fees, which could have an adverse effect on our profit margins and results of operations.”
In addition, if any of our subsidiaries become the sponsor of any SPACs that are unable to successfully complete a business combination within the time limitation provided for such SPAC, we may lose the entirety of our investment. See “We have made a significant investment in a subsidiary that is the sponsor of a SPAC, and will suffer the loss of all of our investment if the SPAC does not complete business combination within two years.”
ARCC’s management fee comprises a significant portion of our management fees and a reduction in fees from ARCC could have an adverse effect on our revenues and results of operations.
The management fees we receive from ARCC (including fees attributable to ARCC Part I Fees) comprise a significant percentage of our management fees. The investment advisory and management agreement we have with ARCC categorizes the
fees we receive as: (a) base management fees, which are paid quarterly and generally increase or decrease based on ARCC’s total assets (excluding cash and cash equivalents), (b) fees based on ARCC’s net investment income (before ARCC Part I Fees and ARCC Part II Fees), which are paid quarterly (“ARCC Part I Fees”) and (c) fees based on ARCC’s net capital gains, which are paid annually (“ARCC Part II Fees”). We classify the ARCC Part I Fees as management fees because they are predictable and recurring in nature, not subject to contingent repayment and generally cash-settled each quarter. If ARCC’s total assets or its net investment income (before ARCC Part I Fees and ARCC Part II Fees) were to decline significantly for any reason, including, without limitation, due to fair value accounting requirements, the poor performance of its investments or the failure to successfully access or invest capital, the amount of the fees we receive from ARCC, including the base management fee and the ARCC Part I Fees, would also decline significantly, which could have an adverse effect on our revenues and results of operations. In addition, because the ARCC Part II Fees are not paid unless ARCC achieves cumulative aggregate realized capital gains (net of cumulative aggregate realized capital losses and aggregate unrealized capital depreciation), ARCC’s Part II Fees payable to us are variable and not predictable. In addition, ARCC Part I Fees and ARCC Part II Fees may be subject to cash payment deferral if certain return hurdles are not met, which could have an adverse effect on our cash flows. ARCC Part I Fees were deferred for the second and third quarters of 2020 and as of December 31, 2020, these fees are now payable under the terms of the investment advisory and management agreement. We may also, from time to time, waive or voluntarily defer any fees payable by ARCC in connection with strategic transactions.
Our investment advisory and management agreement with ARCC renews for successive annual periods subject to the approval of ARCC’s board of directors or by the affirmative vote of the holders of a majority of ARCC’s outstanding voting securities. In addition, as required by the Investment Company Act, both ARCC and its investment adviser have the right to terminate the agreement without penalty upon 60 days’ written notice to the other party. Termination or non-renewal of this agreement would reduce our revenues significantly and could have a material adverse effect on our financial condition.
We may not be able to maintain our current fee structure as a result of industry pressure from fund investors to reduce fees, which could have an adverse effect on our profit margins and results of operations.
We may not be able to maintain our current fee structure as a result of industry pressure from fund investors to reduce fees. Although our investment management fees vary among and within asset classes, historically we have competed primarily on the basis of our performance and not on the level of our investment management fees relative to those of our competitors. In recent years, however, there has been a general trend toward lower fees in the investment management industry. The Institutional Limited Partners Association (“ILPA”) published a set of Private Equity Principles (the “Principles”) which called for enhanced “alignment of interests” between general partners and limited partners through modifications of some of the terms of fund arrangements, including proposed guidelines for fees and performance income structures. We promptly provided ILPA with our endorsement of the Principles, representing an indication of our general support for the efforts of ILPA. Although we have no obligation to modify any of our fees with respect to our existing funds, we may experience pressure to do so. More recently, institutional investors have been increasing pressure to reduce management and investment fees charged by external managers, whether through direct reductions, deferrals, rebates or other means. In addition, we may be asked by investors to waive or defer fees for various reasons, including during economic downturns or as a result of poor performance of our funds. We may not be successful in providing investment returns and service that will allow us to maintain our current fee structure. Fee reductions on existing or future new businesses could have an adverse effect on our profit margins and results of operations. For more information about our fees see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
In addition, we may not be able to maintain our current fee structure if we fail to grow the assets of our funds. This would limit our ability to earn additional management fees and performance income, and ultimately affect our operating results. Our fund investors and potential fund investors continually assess our funds’ performance independently and relative to market benchmarks and our competitors, and our ability to raise capital for existing and future funds and avoid excessive redemption levels depends on our funds’ performance. Accordingly, poor fund performance may deter future investment in our funds and thereby decrease the capital invested in our funds and, ultimately, our management fee income. In the face of poor fund performance, investors could demand lower fees or fee concessions for existing or future funds which would likewise decrease our revenue.
Rapid growth of our businesses, particularly outside the United States, may be difficult to sustain and may place significant demands on our administrative, operational and financial resources.
Our assets under management have grown significantly in the past, and we are pursuing further growth in the near future, both organic and through acquisitions. Our rapid growth has placed, and planned growth, if successful, will continue to place significant demands on our legal, accounting and operational infrastructure and has increased expenses. The complexity of these demands, and the expense required to address them, is a function not simply of the amount by which our assets under management has grown, but of the growth in the variety and complexity of, as well as the differences in strategy between, our
different funds. In addition, we are required to continuously develop our systems and infrastructure in response to the increasing sophistication of the investment management market and legal, accounting, regulatory and tax developments.
Our future growth will depend in part on our ability to maintain an operating platform and management system sufficient to address our growth and will require us to incur significant additional expenses and to commit additional senior management and operational resources. As a result, we face significant challenges in:
•maintaining adequate financial, regulatory (legal, tax and compliance) and business controls;
•providing current and future investors with accurate and consistent reporting;
•implementing new or updated information and financial systems and procedures; and
•training, managing and appropriately sizing our work force and other components of our businesses on a timely and cost-effective basis.
We may not be able to manage our expanding operations effectively or be able to continue to grow, and any failure to do so could adversely affect our ability to generate revenue and control our expenses.
In addition, pursuing investment opportunities outside the United States presents challenges not faced by U.S. investments, such as different legal and tax regimes and currency fluctuations, which require additional resources to address. To accommodate the needs of global investors and strategies we must structure investment products in a manner that addresses tax, regulatory and legislative provisions in different, and sometimes multiple, jurisdictions. Further, in conducting business in foreign jurisdictions, we are often faced with the challenge of ensuring that our activities and those of our funds and, in some cases, our funds’ portfolio companies, are consistent with U.S. or other laws with extraterritorial application, such as the USA PATRIOT Act and the U.S. Foreign Corrupt Practices Act (the “FCPA”). Moreover, actively pursuing international investment opportunities may require that we increase the size or number of our international offices. Pursuing non-U.S. fund investors means that we must comply with international laws governing the sale of interests in our funds, different investor reporting and information processes and other requirements. As a result, we are required to continuously develop our systems and infrastructure, including employing and contracting with foreign businesses and entities, in response to the increasing complexity and sophistication of the investment management market and legal, accounting and regulatory situations. This growth has required, and will continue to require, us to incur significant additional expenses and to commit additional senior management and operational resources. There can be no assurance that we will be able to manage or maintain appropriate oversight over our expanding international operations effectively or that we will be able to continue to grow this part of our businesses, and any failure to do so could adversely affect our ability to generate revenues and control our expenses. See “-Regulatory changes in jurisdictions outside the United States could adversely affect our businesses.”
We may enter into new lines of business and expand into new investment strategies, geographic markets and businesses, each of which may result in additional risks, expenses and uncertainties in our businesses.
We intend, if market conditions warrant, to grow our businesses by increasing assets under management in existing businesses and expanding into new investment strategies, geographic markets and businesses. We may pursue growth through acquisitions of other investment management companies, acquisitions of critical business partners, acquisition of companies, or other strategic initiatives (including through our Strategic Initiatives Group), which may include entering into new lines of business. In addition, consistent with our past experience, we expect opportunities will arise to acquire other alternative or traditional asset managers.
Attempts to expand our businesses involve a number of special risks, including some or all of the following:
•the required investment of capital and other resources;
•the diversion of management’s attention from our core businesses;
•the assumption of liabilities in any acquired business;
•the disruption of our ongoing businesses;
•entry into markets or lines of business in which we may have limited or no experience;
•increasing demands on our operational and management systems and controls;
•our assumption of the imposition on us of known or unknown claims or liabilities in an acquisition, including claims by government agencies or authorities, current or former employees or customers, former stockholders or other third parties;
•compliance with or applicability to our business or our portfolio companies of regulations and laws, including, in particular, local regulations and laws (for example, consumer protection related laws) and customs in the numerous jurisdictions in which we operate and the impact that noncompliance or even perceived noncompliance could have on us and our portfolio companies;
•our inability to realize the anticipated operation and financial benefits from an acquisition for a number of reasons, including if we are unable to effectively integrate acquired businesses;
•potential increase in investor concentration; and
•the broadening of our geographic footprint, increasing the risks associated with conducting operations in certain foreign jurisdictions where we currently have little or no presence.
Entry into certain lines of business may subject us to new laws and regulations with which we are not familiar, or from which we are currently exempt, and may lead to increased litigation and regulatory risk. If a new business does not generate sufficient revenues or if we are unable to efficiently manage our expanded operations, our results of operations will be adversely affected. Our strategic initiatives may include joint ventures and business combinations through subsidiary sponsored SPACs, in which case we will be subject to additional risks and uncertainties in that we may be dependent upon, and subject to liability, losses or reputational damage relating to systems, controls and personnel that are not under our control. Because we have not yet identified these potential new investment strategies, geographic markets or lines of business, we cannot identify all of the specific risks we may face and the potential adverse consequences on us and their investment that may result from any attempted expansion.
If we are unable to consummate or successfully integrate development opportunities, acquisitions or joint ventures, we may not be able to implement our growth strategy successfully.
Our growth strategy is based, in part, on the selective development or acquisition of asset management businesses, advisory businesses or other businesses complementary to our business where we think we can add substantial value or generate substantial returns. The success of this strategy will depend on, among other things, (a) the availability of suitable opportunities, (b) the level of competition from other companies that may have greater financial resources, (c) our ability to value potential development or acquisition opportunities accurately and negotiate acceptable terms for those opportunities, (d) our ability to obtain requisite approvals and licenses from the relevant governmental authorities and to comply with applicable laws and regulations without incurring undue costs and delays, (e) our ability to identify and enter into mutually beneficial relationships with venture partners, and (f) our ability to properly manage conflicts of interest. In addition, our ability to integrate personnel at acquired businesses into our operations and culture may be impacted by the structure of acquisitions we make, such as contingent consideration and continuing governance rights retained by the sellers.
This strategy also contemplates the use of shares of our publicly traded Class A common stock as acquisition consideration. Volatility or declines in the trading price of shares of our Class A common stock may make shares of our Class A common stock less attractive to acquisition targets. Moreover, even if we are able to identify and successfully complete an acquisition, we may encounter unexpected difficulties or incur unexpected costs associated with integrating and overseeing the operations of the new businesses. If we are not successful in implementing our growth strategy, our business, financial results and the market price for shares of our Class A common stock may be adversely affected.
Risk Related to Regulation
Extensive regulation affects our activities, increases the cost of doing business and creates the potential for significant liabilities and penalties that could adversely affect our businesses and results of operations.
Overview of our regulatory environment and exemptions from certain laws. Our businesses are subject to extensive regulation, including periodic examinations, by governmental agencies and self-regulatory organizations in the jurisdictions in which we operate. The SEC oversees the activities of our subsidiaries that are registered investment advisers under the Investment Advisers Act. Since the first quarter of 2014, FINRA and the SEC have overseen the activities of our wholly owned subsidiary AIS LLC as a registered broker-dealer, which also maintains licenses in many states. We are subject to audits by the Defense Security Service to determine whether we are under foreign ownership, control or influence. In addition, we regularly rely on exemptions from various requirements of the Securities Act, the Exchange Act, the Investment Company Act, the Commodity Exchange Act and the U.S. Employee Retirement Income Security Act of 1974, as amended (“ERISA”). These
exemptions are sometimes highly complex and may in certain circumstances depend on compliance by third parties who we do not control. If for any reason these exemptions were to be revoked or challenged or otherwise become unavailable to us, such action could increase our cost of doing business or subject us to regulatory action or third-party claims, which could have a material adverse effect on our businesses. For example, in 2013 the SEC amended Rule 506 of Regulation D under the Securities Act to impose “bad actor” disqualification provisions that ban an issuer from offering or selling securities pursuant to the safe harbor in Rule 506 if the issuer, or any other “covered person,” is the subject of a criminal, regulatory or court order or other “disqualifying event” under the rule which has not been waived by the SEC. The definition of a “covered person” under the rule includes an issuer’s directors, general partners, managing members and executive officers and promoters and persons compensated for soliciting investors in the offering. Accordingly, our ability to rely on Rule 506 to offer or sell securities would be impaired if we or any “covered person” is the subject of a disqualifying event under the rule and we are unable to obtain a waiver or, in certain circumstances, terminate our involvement with such “covered person”.
We expect a greater level of SEC enforcement activity under the new Administration, and while we have a robust compliance program in place, it is possible this enforcement activity will target practices at which we believe we are compliant and which were not targeted by the prior Administration.
Federal regulation. Under the Dodd-Frank Act, a ten voting-member Financial Stability Oversight Council (the “Council”) has the authority to review the activities of certain nonbank financial firms engaged in financial activities that are designated as “systemically important,” meaning, among other things, evaluating the impact of the distress of the financial firm on the stability of the U.S. economy. If we were designated as such, it would result in increased regulation of our businesses, including the imposition of capital, leverage, liquidity and risk management standards, credit exposure reporting and concentration limits, restrictions on acquisitions and annual stress tests by the Federal Reserve.
A section of the Dodd-Frank Act known as the Volcker Rule generally prohibits insured banks or thrifts, any bank holding company or savings and loan holding company, any non-U.S. bank with a U.S. branch, agency or commercial lending company and any subsidiaries and affiliates of such entities, regardless of geographic location, from investing in or sponsoring “covered funds,” which include private equity funds or hedge funds and certain other proprietary activities.
In October of 2020, revisions to the Volcker Rule became effective providing an exemption for activities of qualifying foreign excluded funds, revising the exclusions from the definition of a “covered fund,” creating new exclusions from the definition of a covered fund and modify the definition of an ownership interest. Although we do not currently anticipate that these changes to the Volcker Rule will adversely affect our fundraising to any significant extent, there could be adverse implications on our ability to raise funds from the types of entities mentioned above if these regulations become stricter.
Pursuant to the Dodd-Frank Act, regulation of the U.S. derivatives market is bifurcated between the CFTC and the SEC. Under the Dodd-Frank Act, the CFTC has jurisdiction over swaps and the SEC has jurisdiction over security-based swaps. Under CFTC rules, all swaps (other than security-based swaps) included in the definition of commodity interests. As a result, funds that utilize swaps (whether or not related to a physical commodity) may fall within the statutory definition of a commodity pool. If a fund qualifies as a commodity pool, then, absent an available exemption, the operator of such fund is required to register with the CFTC as a CPO. Registration with the CFTC renders such CPO subject to regulation, including with respect to disclosure, reporting, recordkeeping and business conduct, which could significantly increase operating costs by requiring additional resources.
Certain classes of interest rate swaps and certain classes of credit default swaps are subject to mandatory clearing, unless an exemption applies. Many of these swaps are also subject to mandatory trading on designated contract markets or swap execution facilities. The CFTC may propose rules designating other classes of swaps for mandatory clearing. Mandatory clearing and trade execution requirements may change the cost and availability of the swaps that we use, and exposes our funds to the credit risk of the clearing house through which any cleared swap is cleared. In addition, federal bank regulatory authorities and the CFTC have adopted initial and variation margin requirements for swap dealers, security-based swap dealers and swap entities, including permissible forms of margin, custodial arrangements and documentation requirements for uncleared swaps and security-based swaps. The new rules regarding variation margin requirements are now in effect, and as a result some of our funds are required to post collateral to satisfy the variation margin requirements which has made transacting in uncleared swaps more expensive.
Position limits imposed by various regulators, self-regulatory organizations or trading facilities on derivatives may also limit our ability to effect desired trades. Position limits represent the maximum amounts of net long or net short positions that any one person or entity may own or control in a particular financial instrument. For example, the CFTC, on January 20, 2020, voted to re-propose rules that would establish specific limits on speculative positions in 25 physical commodity futures contracts, futures and options directly or indirectly linked to such contracts as well as economically equivalent swaps. The
CFTC could propose to expand such requirements to other types of contracts in the future. If any were enacted, the proposal could affect our ability and the ability for our funds to enter into derivatives transactions.
In January, 2019, rules enacted by the Board of Governors of the Federal Reserve System, FDIC and the OCC came into effect and placed limitations on the exercise of certain specified insolvency-related default and cross-default rights against a counterparty that has been designated as a global systemically important banking organization (the “Stay Regulations”). These rules are intended to mitigate the risk of destabilizing close-outs of certain qualifying financial contracts (“QFCs”) (including but not limited to, derivatives, securities lending, and short-term funding transactions, such as repurchase agreements) entered into by U.S. global systemically important banking organizations. The ultimate impact of the Stay Regulations on our business will not be known unless one or more counterparties with whom we have QFCs experiences a covered insolvency event, but it could be material.
The Dodd-Frank Act authorizes federal regulatory agencies to review and, in certain cases, prohibit compensation arrangements at financial institutions that give employees incentives to engage in conduct deemed to encourage inappropriate risk-taking by covered financial institutions. In 2016, federal bank regulatory authorities and the SEC revised and re-proposed a rule that generally (1) prohibits incentive-based payment arrangements that are determined to encourage inappropriate risks by certain financial institutions by providing excessive compensation or that could lead to material financial loss and (2) requires those financial institutions to disclose information concerning incentive-based compensation arrangements to the appropriate federal regulator. For more information on certain incentive compensation paid to our senior executive officers, see “The market price of shares of our Class A common stock may decline due to the large number of shares of Class A common stock eligible for exchange and future sale.” The Dodd-Frank Act also directs the SEC to adopt a rule that requires public companies to adopt and disclose policies requiring, in the event the company is required to issue an accounting restatement, the contingent repayment obligations of related incentive compensation from current and former executive officers. The SEC has proposed but not yet adopted such rule. To the extent the aforementioned rules are adopted, our ability to recruit and retain investment professionals and senior management executives could be limited.
It is difficult to determine the full extent of the impact on us of new laws, regulations or initiatives that may be proposed or whether any of the proposals will become law. In addition, as a result of proposed legislation, shifting areas of focus of regulatory enforcement bodies or otherwise, regulatory compliance practices may shift such that formerly accepted industry practices become disfavored or less common. Any changes or other developments in the regulatory framework applicable to our businesses, including the changes described above and changes to formerly accepted industry practices, may impose additional costs on us, require the attention of our senior management or result in limitations on the manner in which we conduct our businesses. Moreover, as calls for additional regulation have increased, there may be a related increase in regulatory investigations of the trading and other investment activities of alternative asset management funds, including our funds. In addition, we may be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental authorities and self-regulatory organizations. Compliance with any new laws or regulations could make compliance more difficult and expensive, affect the manner in which we conduct our businesses and adversely affect our profitability.
State regulation. Since 2010, states and other regulatory authorities have begun to require investment managers to register as lobbyists. We have registered as such in a number of jurisdictions, including California, Illinois, New York, Pennsylvania, Louisiana, Texas and Kentucky. Other states or municipalities may consider similar legislation or adopt regulations or procedures with similar effect. These registration requirements impose significant compliance obligations on registered lobbyists and their employers, which may include annual registration fees, periodic disclosure reports and internal recordkeeping, and may also prohibit the payment of contingent fees.
Regulatory environment of our funds and portfolio companies of our funds. Each of the regulatory bodies with jurisdiction over us has regulatory powers dealing with many aspects of financial services, including the authority to grant, and in specific circumstances to cancel, permissions to carry on particular activities. A failure to comply with the obligations imposed by the Investment Advisers Act, including recordkeeping, advertising and operating requirements, disclosure obligations and prohibitions on fraudulent activities, could result in investigations, sanctions, restrictions on the activities of us or our personnel and reputational damage. We are involved regularly in trading activities that implicate a broad number of U.S. and foreign securities and tax law regimes, including laws governing trading on inside information, market manipulation and a broad number of technical trading requirements that implicate fundamental market regulation policies. Violation of these laws could result in severe restrictions on our activities and damage to our reputation.
Compliance with existing and new regulations subjects us to significant costs. Moreover, our failure to comply with applicable laws or regulations, including labor and employment laws, could result in fines, censure, suspensions of personnel or other sanctions, including revocation of the registration of our relevant subsidiaries as investment advisers or registered broker-dealers. For example, the SEC requires investment advisers registered or required to register with the SEC under the Investment
Advisers Act that advise one or more private funds and have at least $150.0 million in private fund assets under management to periodically file reports on Form PF. We have filed, and will continue to file, quarterly reports on Form PF, which has resulted in increased administrative costs and requires a significant amount of attention and time to be spent by our personnel. Most of the regulations to which our businesses are subject are designed primarily to protect investors in our funds and portfolio companies and to ensure the integrity of the financial markets. They are not designed to protect our stockholders. Even if a sanction is imposed against us, one of our subsidiaries or our personnel by a regulator for a small monetary amount, the costs incurred in responding to such matters could be material, the adverse publicity related to the sanction could harm our reputation, which in turn could have a material adverse effect on our businesses in a number of ways, making it harder for us to raise new funds and discouraging others from doing business with us.
In the past several years, the financial services industry, and private equity and alternative asset managers in particular, has been the subject of heightened scrutiny by regulators around the globe. In particular, the SEC and its staff have focused more narrowly on issues relevant to alternative asset management firms, including by forming specialized units devoted to examining such firms and, in certain cases, bringing enforcement actions against the firms, their principals and employees. In recent periods there have been a number of enforcement actions within the industry, and it is expected that the SEC will continue to pursue enforcement actions against private fund managers. This increased enforcement activity may cause us to reevaluate certain practices and adjust our compliance control function as necessary and appropriate.
A number of our investing activities, such as our direct lending business, are also subject to regulation by various U.S. and foreign regulators. It is impossible to determine the full extent of the impact on us of existing regulation or any other new laws, regulations or initiatives that may be proposed or whether any of the proposals will become law. Any changes in the regulatory framework applicable to our businesses, including the changes described above, may impose additional costs on us, require the attention of our senior management or result in limitations on the manner in which we conduct our business. Complying with any new laws or regulations could be more difficult and expensive, affect the manner in which we conduct our businesses and adversely affect our profitability. As of December 31, 2020, our direct lending AUM represented 50.2% of our total AUM.
In May 2020, our subsidiary Ares Management LLC consented to the entry of an administrative and cease-and-desist order (the “Order”) instituted by the SEC relating to the insufficient implementation and enforcement of Ares’ written policies and procedures regarding the prevention of misuse of potentially material nonpublic information (“MNPI”) in 2016 when Ares had an employee serving on the board of directors of a public company in which one of its clients was invested. The Order did not find any misuse of MNPI by Ares or its employees; however, the Order included cease and desist provisions and a censure, and payment of a civil penalty in the amount of $1.0 million.
While the SEC’s recent lists of examination priorities include such items as cybersecurity compliance and controls and conducting risk-based examinations of investment advisory firms, it is generally expected that the SEC’s oversight of alternative asset managers will continue to focus substantially on concerns related to fiduciary duty transparency and investor disclosure practices. Although the SEC has cited improvements in disclosures and industry practices in this area, it has also indicated that there is room for improvement in particular areas, including fees and expenses (and the allocation of such fees and expenses) and co-investment practices. To this end, many firms have received inquiries during examinations or directly from the SEC’s Division of Enforcement regarding various transparency-related topics, including the acceleration of monitoring fees, the allocation of broken-deal expenses, the disclosure of operating partner or operating executive compensation, outside business activities of firm principals and employees, group purchasing arrangements and general conflicts of interest disclosures. In addition, our Private Equity Group funds have engaged in the past and may engage from time to time advisors who often work with our investment teams during due diligence, provide board-level governance and support and advise portfolio company leadership. Advisors generally are third parties and typically retained by us pursuant to consulting agreements. In some cases, an operating executive may be retained by a portfolio company directly and in such instances the portfolio company may compensate the operating executive directly (meaning that investors in our Private Equity Group funds may indirectly bear the operating executive’s compensation). While we believe we have made appropriate and timely disclosures regarding the engagement and compensation of these advisors, the SEC staff may disagree.
Further, the SEC has highlighted valuation practices as one of its areas of focus in investment adviser examinations and has instituted enforcement actions against advisers for misleading investors about valuation. If the SEC were to investigate and find errors in our methodologies or procedures, we and/or members of our management could be subject to penalties and fines, which could harm our reputation and our business, financial condition and results of operations could be materially and adversely affected.
Regulations impacting the insurance industry could adversely affect our business and our operations.
The insurance industry is subject to significant regulatory oversight, both in the U.S. and abroad. Regulatory authorities in many relevant jurisdictions have broad administrative, and in some cases discretionary, authority with respect to insurance companies and/or their investment advisors, which may include, among other things, the investments insurance companies may acquire and hold, marketing practices, affiliate transactions, reserve requirements, capital adequacy including insurance company licensing and examination, agent licensing, establishment of reserve requirements and solvency standards, premium rate regulation, admissibility of assets, policy form approval, unfair trade and claims practices, advertising, maintaining policyholder privacy, payment of dividends and distributions to shareholders, investments, review and/or approval of transactions with affiliates, reinsurance, acquisitions, mergers and other matters. Insurance regulatory authorities regularly review and update these and other requirements. Currently, there are proposals to increase the scope of regulation of insurance holding companies in the U.S., Bermuda and other jurisdictions. Changes in regulations impacting the insurance industry could adversely impact our expansion into the insurance industry, the prospects of our Bermuda insurance company subsidiary Aspida Life Re Ltd. (formerly known as F&G Reinsurance Ltd) and other investments we make in the insurance industry and limit our ability to raise capital for our funds from insurance companies, which could limit our ability to grow.
We may be the target or subject of, or may have indemnification obligations related to, litigation, enforcement investigations or regulatory scrutiny. Regulators and other authorities generally have the power to bring administrative or judicial proceedings against insurance companies, which could result in, among other things, suspension or revocation of licenses, cease and desist orders, fines, civil penalties, criminal penalties or other disciplinary action. To the extent AIS or another Ares business that offers products to insurance companies, or our subsidiary Aspida Life Re Ltd., is directly or indirectly involved in such regulatory actions, our reputation could be harmed, we may become liable for indemnification obligations and we could potentially be subject to enforcement actions, fines and penalties.
Insurance company investment portfolios are often subject to internal and regulatory requirements governing the categories and ratings of investment products they may acquire and hold. Many of the investment products we develop for, or other assets or investments we include in, insurance company portfolios will be rated and a ratings downgrade or any other negative action by a rating agency with respect to such products, assets or investments could make them less attractive and limit our ability to offer such products to, or invest or deploy capital on behalf of, insurers.
As the ultimate parent of the controlling entity of Aspida Life Re Ltd, a Bermuda Class E insurance company, we are considered its “shareholder controller” (as defined in the Bermuda Insurance Act) by the Bermuda Monetary Authority, or BMA. Aspida Life Re Ltd. is subject to regulation and supervision by the BMA, and compliance with all applicable Bermuda law and Bermuda insurance statutes and regulations, including but not limited to the Bermuda Insurance Act. Under the Bermuda Insurance Act, the BMA maintains supervision over the “controllers” of all registered insurers in Bermuda. For these purposes, a “controller” includes a shareholder controller (as defined in the Bermuda Insurance Act). The Bermuda Insurance Act imposes certain notice requirements upon any person that has become, or as a result of a disposition ceased to be, a shareholder controller, and failure to comply with such requirements is punishable by a fine or imprisonment or both. In addition, the BMA may file a notice of objection to any person or entity who has become a controller of any description where it appears that such person or entity is not, or is no longer, fit and proper to be a controller of the registered insurer, and such person or entity can be subject to fines or imprisonment or both. These laws may discourage potential acquisition proposals for us and could delay, deter or prevent an acquisition of controllers of Bermuda insurers.
Changes to the method of determining the London Interbank Offered Rate (“LIBOR”) or the selection of a replacement for LIBOR may affect the value of investments held by us or our funds and could affect our results of operations and financial results.
In March 2013, the predecessor regulator to the FCA published final rules for the FCA’s regulation and supervision of the London Interbank Offered Rate (“LIBOR”). In particular, the FCA’s LIBOR rules include requirements that (1) an independent LIBOR administrator monitor and survey LIBOR submissions to identify breaches of practice standards and/or potentially manipulative behavior, and (2) firms submitting data to LIBOR establish and maintain a clear conflicts of interest policy and appropriate systems and controls. These requirements may cause LIBOR to be more volatile than it has been in the past, which may adversely affect the value of investments made by our funds. On February 3, 2014, ICE Benchmark Administration Limited took responsibility for administering LIBOR, following regulatory authorization by the FCA. In July 2017, the FCA announced that it would phase out LIBOR by the end of 2021. The current nominated replacement for United States Dollar-LIBOR is the Secured Overnight Financing Rate (“SOFR”) and the nominated replacement for GDP-LIBOR is the Sterling Overnight Interbank Average Rate (“SONIA”). In March 2020, the Federal Reserve began publishing 30-, 90- and 180-day tenor SOFR Averages and a SOFR Index and in July 2020, Bloomberg began publishing fall-backs that the International Swaps and Derivatives Association (“ISDA”) intends to implement in lieu of LIBOR with respect to swaps and derivatives. In many cases, the nominated replacements, as well as other potential replacements, are not complete or ready to
implement and require margin adjustments. On November 30, 2020, the ICE Benchmark Administration (“IBA”), the FCA-regulated LIBOR administrator, announced its intention to (i) consult on LIBOR cessation in December 2020 and, (ii) to the extent confirmed during such consultation, to cease the one-week and two-month United States Dollar (“USD”)-LIBOR tenors by December 31, 2021, and to cease all other USD-LIBOR tenors by June 30, 2023. Further, as of December 31, 2020, there is no forward-looking term-rate SOFR available and there is no guarantee that one will become available prior to the full discontinuation of LIBOR.
It is unclear what methods of calculating a replacement benchmark will be established or adopted generally, and whether different industry bodies, such as the loan market and the derivatives market will adopt the same methodologies. Changes in the method of calculating LIBOR, or the replacement of LIBOR with an alternative rate or benchmark, may adversely affect interest rates and result in higher borrowing costs. If LIBOR ceases to exist, we, our investments funds and our portfolio companies may need to amend or restructure our existing LIBOR-based debt instruments and any related hedging arrangements that extend beyond 2021, which may be difficult, costly and time consuming and may result in adverse tax consequences. In addition, from time to time our funds invest in floating rate loans and investment securities whose interest rates are indexed to LIBOR. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR, or any changes announced with respect to such reforms, may result in a sudden or prolonged increase or decrease in the reported LIBOR rates and the value of LIBOR-based loans and securities, including those of other issuers we or our funds currently own or may in the future own, and may impact the availability and cost of hedging instruments and borrowings, including potentially, an increase to our and our funds' interest expense and cost of capital. Any increased costs or reduced profits as a result of the foregoing may adversely affect our liquidity, results of operations and financial condition.
Regulatory changes in jurisdictions outside the United States could adversely affect our businesses.
Certain of our subsidiaries operate outside the United States. In Luxembourg, Ares Management Luxembourg is subject to regulation by the CSSF. In the U.K., AML and AMUKL are subject to regulation by the FCA. AELM, which is not a subsidiary, but in which we are indirectly invested and which procures certain services from AML, is also subject to regulation by the FCA. In some circumstances, AML, AMUKL, AELM and other Ares entities are or become subject to U.K. or EU laws, for instance in relation to marketing our funds to investors in the EEA.
The U.K. exited the EU on January 31, 2020. The withdrawal agreement between the U.K. and the EU provided for a transitional period to allow for the terms of the U.K.’s future relationship with the EU to be negotiated, which ended on December 31, 2020. EEA passporting rights are no longer available to the relevant U.K. entities following the end of the transitional period. Various EU laws have been “on-shored” into domestic U.K. legislation and certain transitional regimes and deficiency-correction powers exist to ease the transition.
The U.K. and the EU announced, on December 24, 2020, that they have reached agreement on a new Trade and Cooperation Agreement (the “TCA”), which addresses the future relationship between the parties. Notwithstanding the TCA, there remains considerable uncertainty as to the nature of the U.K.’s future relationship with the EU (particularly in the sphere of financial services), creating continuing uncertainty as to the full extent to which the businesses of the U.K. Regulated Entities could be adversely affected by Brexit. See “-The U.K.’s exit from the EU (“Brexit”) could adversely affect our business and our operations.”
Despite the U.K.’s departure from the EU, new and existing EU legislation is expected to be phased out overcontinue to impact our business in the coming years. The BankU.K. (whether because its effect is preserved in the U.K. as a matter of England working group has approved Sterling Overnight Interest Average (“SONIA”) as its preferred short-term interest benchmark and will take over its administration from April 2018. The impact this change will havedomestic policy or because compliance with such legislation (whether in whole or part) is uncertain.
The EU Benchmarks Regulation (the “Benchmarks Regulation”) entereda necessary condition for market access into force on June 30, 2016. It aims to introduce a common framework and consistent approach to benchmark regulation across the EU by regulating producers, contributors to and users of benchmarks. The Benchmarks Regulation will replace the current UK framework regulating LIBOREEA) and other specified benchmarks, notably the Euro interbank offered rate (“EURIBOR”).EEA member states where we have operations. The majorityfollowing EU measures are of provisions in the Benchmarks Regulation took effect on January 1, 2018. Although there are measures in the Benchmarks Regulation which are designedparticular relevance to prevent certain benchmarks from being undermined by a material reduction of benchmark contributors, it is not yet clear how successful these will be. The Benchmarks Regulation may therefore lead to unpredictable developments in relation to LIBOR and certain other benchmarks, which could affect the value of investments made by our funds.business.
The EU Capital Requirements Directive IV and Capital Requirements Regulation (collectively, “CRD IV”) and the EU Alternative Investment Fund Managers Directive (the “Directive”) restrict the ability of banks and alternative investment funds (“AIFs”) managed in the EU to invest in securitization vehicles including collateralized loan obligations operated by us unless either the “originator”, “original lender” or “sponsor” (as those terms are defined in the legislation) retains a 5% interest in the securitization concerned. Where such securitization arrangements are managed by Ares-affiliated undertakings, and in order to make the securitization attractive to banks and AIFs, this risk retention requirement is held by an appropriately (EU) authorized and regulated entity affiliated with us (i.e., as “sponsor”). The holding of that retention on our affiliate’s balance sheet is likely to increase that entity’s regulatory capital requirement and will accordingly adversely affect return on equity. On December 28, 2017 the text of the new Securitization Regulation was published in the EU Official Journal. The new regulation will apply from January 1, 2019, the new EU Securitisation Regulation (the “Securitisation Regulation”) came into effect and applies to securitizationsecuritizations issued after that date. AlthoughAmong other things, the Securitisation Regulation includes requirements in relation to transparency and risk retention requirements will remain at 5% (of material net economic interest)and restricts AIFMs from investing in securitizations which do not comply with its provisions (“non-compliant securitizations”). The Securitisation Regulation also imposes an obligation on AIFMs to divest where they hold an interest in a mechanism has been introduced whereby this requirementnon-compliant securitization. It is currently unclear if the Regulation applies to AIFMs domiciled outside the EEA but marketing one or more alternative investment funds in the EEA under a national private placement regime. This lack of clarity may hamper our ability to raise capital for some of our non-EEA funds from investors in the EEA or subject such fund raising to additional risks, including, if application of the Securitisation Regulation to non-EEA AIFMs is confirmed, that their funds that market in the EEA could be modified withoutrequired to divest of interests in non-compliant securitizations at sub-optimal prices. The U.K. has on-shored the need for the changeSecuritisation Regulation and therefore similar requirements continue to be made through the normal EU legislative process. There are also new investor transparency requirements which require additional information to be disclosed to investors. Compliance with these new requirementsapply in the Securitization Regulation may result in us incurring material costs.U.K. notwithstanding Brexit.
The EU Regulation on OTCover-the-counter (“OTC”) derivative transactions, central counterparties and trade repositories (commonly known as the(the “European Market Infrastructure Regulation” or “EMIR”) will requirerequires the mandatory clearing of certain over-the-counter (“OTC”)OTC derivatives through central counterparties, and creates additional risk mitigation requirements (including, in particular, margining requirementsrequirements) in respect of certain OTC derivative transactions that are not cleared by a central counterparty.counterparty and imposes reporting and record keeping requirements in respect of most derivative transactions. The implementationrequirements are similar to, but not the same as, those in Title VII of the Dodd-Frank Act. The U.K. has on-shored EMIR is phased; timing is dependentand a similar but not identical set of rules therefore now apply in the U.K. notwithstanding Brexit. Certain cross-border arrangements (such as those where an Ares European fund enters into derivatives transactions with a U.K. counterparty, transacts on a U.K. trading venue or clears its derivatives through a U.K. clearing house) may be impacted. Compliance with the type of derivativerelevant requirements in the EU and the categorization of the parties to the trade. Implementation deadlines have already been deferred but as they currently stand full implementation is due by July 9, 2019. EMIR has started to impact on Ares-affiliated undertakings and as further implementation dates are reached the cost of complying with the requirementsU.K. (as applicable) is likely to increase. In addition, there is an amendmentcontinue to EMIRincrease the burdens and costs of doing business.
A new EU Regulation on the prudential requirements of investment firms (Regulation (EU) 2019/2033) and its accompanying Directive (Directive (EU) 2019/2034) (together, “IFR/IFD”) have now been finalized and are expected to take effect on June 26, 2021. IFR/IFD will introduce a bespoke prudential regime for most MiFID investment firms to replace the one that currently working its way throughapplies under the fourth Capital Requirements Directive and the Capital Requirements Regulation. IFR/IFD represents a complete overhaul of “prudential” regulation in the EU. Depending on how EU the legislative process. Among other things the amendment would classify securitization special purpose entities as financial counterparties which may indirectly impactmember states implement IFR/IFD, certain aspects of our business.
On December 14, 2015,these rules may also apply AIFMs that have been authorized to provide investment services via a MiFID “top-up” permission, such as Ares Management Luxembourg. The U.K. has confirmed that it will be implementing its own version of IFR/IFD, the European Banking Authority published guidelinesInvestment Firm Prudential Regulation (the “IFPR”), which are relevantwas initially expected to among other things, EU banks' exposurestake effect from June 2021 in line with IFR/IFD but is now expected to shadow banking entities. These guidelines became effective ontake effect from January 1, 2017.2022. The definition of a shadow banking entity is extremely wide and could potentially include a number of different entities, such as investment funds and securitization vehicles. AIFs are excluded from the definition of a shadow banking entity unless they: (1) deploy leverage within the meaning of the Directive on a substantial basis; or (2) are permitted to originate loans or purchase third party lending exposures onto their balance sheet pursuant to the relevant fund rules or constitutional documents. These guidelines may affect our ability to raise capital in certain of our funds from EU banks.
On December 20, 2017, the European Commission published a proposal for a new directive and regulation on prudential requirements for MiFID investment firms, and the proposalIFPR will directly apply to our subsidiaries Ares Management Limited and Ares European Loan Management LLP. Its applicationLLP as U.K. MiFID investment firms. The extent to which the IFPR will apply to Ares Management UK Limited, as a U.K. AIFM with a MiFID “top-up” permission, is unclear. Underas yet unclear and further clarity on this point is expected to emerge in future FCA consultations on the proposals mostnew regime. The new prudential regimes are expected to result in higher regulatory capital requirements for some affected firms would see their capitaland new, more onerous remuneration rules, as well as re-cut and extended internal governance, disclosure, reporting, liquidity, and group “prudential” consolidation requirements increase significantly,(among other things), each of which could have a material impact on Ares’ European operations, although there would beare transitional provisions allowing
firms to increase their capital toduring an initial period following the necessary level over three to five years. Firms will also have their liquidity requirements increased and some firms will be subject to additional public reporting requirements and pay regulation. The proposals are likely to increase the cost of us conducting business in the EEA. The legislative package is not expected to comenew regimes coming into force until 2020 at the earliest.force.
Our U.K., other European and Asian operations and our investment activities worldwide are subject to a variety of regulatory regimes that vary by country. In the EU, examples of further legislation include proposals for further changes to or reviews of the extent and interpretation of pay regulation, including under IFR/IFD (which may have an impact on the retention and recruitment of key personnel), proposals for enhanced regulation of loan origination, credit servicing and new reporting requirements in relation to securities financing transactions. In the U.K., there have been additional changes (effective since December 2019) to the rules concerning the approval of certain Ares professionals in the U.K. to work in the regulated financial services sector. Assessing the impact and implementing these new rules may create additional compliance burden and cost for us. In addition, we regularly rely on exemptions from various requirements of the regulations of certain foreign countries in conducting our asset management activities.
Each of the regulatory bodies with jurisdiction over us has regulatory powers dealing with many aspects of financial services, including the authority to grant, and in specific circumstances to cancel, permissions to carry on particular activities. We are involved regularly in trading activities that implicate a broad number of foreign (as well as U.S.) securities law regimes, including laws governing trading on inside information and market manipulation and a broad number of technical trading requirements that implicate fundamental market regulation policies. Violation of these laws could result in severe restrictions or prohibitions on our activities and damage to our reputation, which in turn could have a material adverse effect on our businesses in a number of ways, making it harder for us to raise new funds and discouraging others from doing business with us. In addition, increasing global regulatory oversight of fundraising activities, including local registration requirements in various jurisdictions and the addition of new compliance regimes, could make it more difficult for us to raise new funds or could increase the cost of raising such funds.
Alternative Investment Fund Managers Directive (the "Directive")
The Directive was enacted in July 2011 and took effect on July 22, 2013. The Directive2013 and applies to (1) Alternative Investment Fund Managers (“AIFMs”)AIFMs established in the EEA that manage EEA or non‑EEAnon-EEA AIFs, (2) non‑EEAnon-EEA AIFMs that manage EEA AIFs and (3) non‑EEAnon-EEA AIFMs that market their AIFs to professional investors within the EEA.
Beginning July 22, 2013, Non-EEA AIFMs do not currently benefit from marketing passport rights and may only market AIFs to investors in some EEA jurisdictions in accordance with national private placement regimes. The U.K. implemented AIFMD while it was still a member of the Directive imposed new operatingEU and similar requirements the categories of AIFMs listed at (1) and (2)therefore continue to apply in the paragraph above. In addition, each of the AIFMs identified at (1), (2) and (3) of the paragraph above will need to comply with the Directive’s disclosure and transparency requirements when seeking to market within the EEA and, in the case of non‑EEA AIFMs seeking to market under jurisdiction specific private placement regimes, additional jurisdiction specific requirements where these exist (e.g., appointing a depositary).U.K. notwithstanding Brexit.
The full scope of the Directive may also be extended on a jurisdiction-by-jurisdiction basis to non‑EEA AIFMs that wish to market an AIF within the EEA pursuant to a pan‑European marketing passport. In July 2016, the European Securities and Markets Authority (“ESMA”) published advice to EU institutions on extending the passport to certain non-EU jurisdictions. This included positive assessments in respect of extending the passport under the Directive to five non-EEA jurisdictions, which notably did not include the United States or the Cayman Islands. ESMA expressed a qualified assessment in respect of the United States due to concerns about reciprocity of market access. ESMA gave no assessment in respect of the Cayman Islands. The European Commission was expected and arguably required to publish legislation before the end of October 2016 setting a date for the pan-European marketing passport to be made available, at least in respect of the five non-EEA jurisdictions it had assessed positively. In 2017 the European Commission started a review of AIFMD. The European Commission published a report on the operation of AIFMD in January 2019, which identified certain areas requiring further analysis. A subsequent report on the application and scope of AIFMD. TheAIFMD was published in June 2020. Following these reports, the European Commission launched a
public consultation relating to its review of the AIFMD in October 2020 (which closes on 29 January 2021). This is expected to makeresult in a legislative proposal as a result of the review (commonly referred to as "AIFMD II"“AIFMD II”) with any changes. AIFMD imposes a range of requirements on AIFMs and “leveling up” of these requirements under AIFMD II seems likely, which may increase the cost of doing business for Ares Management Luxembourg and Ares’ non-EEA AIFMs (including Ares Management UK Limited) wishing to non-EEA jurisdiction passporting rights forming partmarket funds in the EEA and potentially disadvantages our funds as investors in private companies located in EEA member states when compared to non-AIF/AIFM competitors that may not be subject to such requirements. Although the reports and public consultation gives some indication of the proposal.direction of travel, the substance of any legislative proposal remains uncertain and it is unclear whether and how any such legislation will affect us or our subsidiaries. Compliance with AIFMD II has the potential to increase the cost and complexity of raising capital and consequently may slow the pace of fundraising. It is not yet clear to what extent (if any) the U.K. will seek to reflect AIFMD II in its domestic rules implementing AIFMD.
Certain of the jurisdiction specific private placement regimes may cease to exist whenif the non-EEA AIFM passport becomes available. This development could have a negative impact on our ability to raise capital from EEA investors if, for example, a jurisdiction specific private placement regime ceases to operate and the non-EEA AIFM passport is not made available to United States AIFMs.
The operating requirements imposed by the Directive include, among other things, rules relating In addition to the remunerationfurther changes to the AIFMD, a wider review is ongoing which may lead to further changes both under the AIFMD and potentially in other areas of certain personnel, minimum regulatory capitalEU regulation, possibly leading to increased costs and/or burdens and more limit operational flexibility within the EEA and access to EEA investors.
EU measures on the cross-border distribution of investment funds
A new package of measures which will amend the existing regimes governing the cross-border distribution of collective investment funds in the EU (the “CBD Directive” and the “CBD Regulation”) came into force on August 1, 2019. The changes are largely expected to take effect from August 2, 2021. The CBD Directive and CBD Regulation amend the existing rules on the distribution of investment funds under AIFMD and The Undertakings for Collective Investment in Transferable Securities Directive (2009/65/EC). The CBD Directive amends the existing regimes for the cross-border marketing of funds and the CBD Regulation introduces new standardized requirements for cross-border fund distribution in the EU. The key changes include a new harmonized “pre-marketing” regime under AIFMD, more transparency and principles for calculating supervisory fees, new procedures for the de-notification of marketing including restrictions on pre-marketing successor funds, regulation of marketing communication as well as additional regulation in relation to reverse solicitation, with further changes expected to follow. The new regulations have the use of leverage, restrictions on early distributions relatingpotential to portfolio companies (so called “asset stripping rules”), disclosure and reporting requirementshamper our ability to bothraise capital from EEA investors and home state regulators, the independent valuation of an AIF’s assets and the appointment of an independent depository to hold assets. As a result, the Directive increases the regulatory burden andincrease the cost of doing business for Ares Management UK Limited and, to a more limited extent, non-EEA AIFMs which market to non-EEA AIFs under EEA private placement regimes. This potentially disadvantages our funds as investors in private companies located in EEA member states when compared to non‑AIF/AIFM competitors that may not be subject to the requirements of the Directive, thereby potentially restricting our funds’ ability to invest in such companies. “Levelling-up” of some of these requirements seems likely under AIFMD II.so.
The Directive could also limit our operating flexibility and our investment opportunities, as well as expose us and/or our funds to conflicting regulatory requirements in the United States (and elsewhere).
Solvency IIAlternative Investment Fund Managers Directive
The Directive 2009/138/ECtook effect on July 22, 2013 and applies to (1) AIFMs established in the EEA that manage EEA or non-EEA AIFs, (2) non-EEA AIFMs that manage EEA AIFs and (3) non-EEA AIFMs that market their AIFs to professional investors within the EEA. Non-EEA AIFMs do not currently benefit from marketing passport rights and may only market AIFs to investors in some EEA jurisdictions in accordance with national private placement regimes. The U.K. implemented AIFMD while it was still a member of the EU and similar requirements therefore continue to apply in the U.K. notwithstanding Brexit.
In 2017 the European Commission started a review of AIFMD. The European Commission published a report on the taking‑upoperation of AIFMD in January 2019, which identified certain areas requiring further analysis. A subsequent report on the application and pursuitscope of AIFMD was published in June 2020. Following these reports, the European Commission launched a
public consultation relating to its review of the AIFMD in October 2020 (which closes on 29 January 2021). This is expected to result in a legislative proposal (commonly referred to as “AIFMD II”). AIFMD imposes a range of requirements on AIFMs and “leveling up” of these requirements under AIFMD II seems likely, which may increase the cost of doing business of Insurancefor Ares Management Luxembourg and Reinsurance (“Solvency II”) sets out stronger capital adequacyAres’ non-EEA AIFMs (including Ares Management UK Limited) wishing to market funds in the EEA and risk management requirements for European insurers and reinsurers and,potentially disadvantages our funds as investors in particular, dictates how much capital such firms must hold against their liabilities and introduces a risk‑based assessment of those liabilities. Solvency II came into force on January 1, 2010 but was only requiredprivate companies located in EEA member states when compared to be implemented by firms on January 1, 2016. There are also a number of transitional provisions designed to avoid market disruption. Solvency II imposes, among other things, substantially greater quantitative and qualitative capital requirements for insurers and reinsurers as well as other supervisory and disclosure requirements. We arenon-AIF/AIFM competitors that may not subject to Solvency II; however, many of our European insurer or reinsurer fund investors are subject to this directive, as applied under applicable domestic law. Solvency II may impact insurers’ and reinsurers’ investment decisions and their asset allocations. In addition, insurers and reinsurers will be subject to more onerous data collationsuch requirements. Although the reports and reporting
requirements. As a result, Solvency II could have an adverse indirect effect onpublic consultation gives some indication of the direction of travel, the substance of any legislative proposal remains uncertain and it is unclear whether and how any such legislation will affect us or our businesses by, among other things, restricting the ability of European insurers and reinsurers to invest in our funds and imposing on us extensive disclosure and reporting obligations for those insurers and reinsurers that do invest in our funds. A number of reviews of and amendments to various aspects and components of Solvency II are expected throughout 2018.
MiFID II
The recast Markets in Financial Instruments Directive and Markets in Financial Instruments Regulation (collectively referred to as MiFID II) came into effect on January 3, 2018. MiFID II amends the existing MiFID regime and, among other requirements, introduces new organizational and operational requirements for investment firms in the EEA.subsidiaries. Compliance with these new rules requires updates to some existing procedures, systems and controls and the development of new internal systems, which may include substantial automated and electronic systems, and is likely to involve material costs to the business.
European Union Referendum in the United Kingdom
On June 23, 2016, the United Kingdom ("UK") electorate voted in support of the UK leaving the European Union ("EU"). The implications of the UK’s pending withdrawal from the EU are unclear at present because the relationship between the UK and the EU after such withdrawal is unclear. It is likely that this matter will be negotiated over the next several years. As a result, our ability to, among other things, (1) market interests in our funds to EU investors; and/or (2) lend to EU borrowers or invest in EU assets may be adversely affected.
Competition
The investment management industry is intensely competitive, and we expect it to remain so. We compete both globally and on a regional, industry and asset basis.
We face competition both in the pursuit of fund investors and investment opportunities. Generally, our competition varies across business lines, geographies and financial markets. We compete for outside investors based on a variety of factors, including investment performance, investor perception of investment managers’ drive, focus and alignment of interest, quality of service provided to and duration of relationship with investors, breath of our product offering, business reputation and the level of fees and expenses charged for services. We compete for investment opportunities based on a variety of factors, including breadth of market coverage and relationships, access to capital, transaction execution skills, the range of products and services offered, innovation and price.
We expect to face competition in our direct lending, trading, acquisitions and other investment activities primarily from business development companies, credit and real estate funds, specialized funds, hedge fund sponsors, financial institutions, private equity funds, corporate buyers and other parties. Many of these competitors in some of our businesses are substantially larger and have considerably greater financial, technical and marketing resources than are available to us. Many of these competitors have similar investment objectives to us, which may create additional competition for investment opportunities. Some of these competitors may also have a lower cost of capital and access to funding sources that are not available to us, which may create competitive disadvantages for us with respect to investment opportunities. In addition, some of these competitors may have higher risk tolerances, different risk assessments or lower return thresholds, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we want to make. Corporate buyers may be able to achieve synergistic cost savings with regard to an investment that may provide them with a competitive advantage in bidding for an investment. Lastly, institutional and individual investors are allocating increasing amounts of capital to alternative investment strategies. Several large institutional investors have announced a desire to consolidate their investments in a more limited number of managers. We expect that this will cause competition in our industry to intensify and could lead to a reduction in the size and duration of pricing inefficiencies that many of our funds seek to exploit.
Competition is also intense for the attraction and retention of qualified employees. Our ability to continue to compete effectively in our businesses will depend upon our ability to attract new employees and retain and motivate our existing employees.
For additional information concerning the competitive risks that we face, see “Item 1A. Risk Factors—Risks Related to Our Businesses—The investment management business is intensely competitive.”
Available Information
Ares Management, L.P. was formed as a Delaware limited partnership on November 15, 2013. Our principal executive offices are located at 2000 Avenue of the Stars, 12th Floor, Los Angeles, California 90067, and our telephone number is (310) 201- 4100.
Our website address is http://www.aresmgmt.com. Information on our website is not a part of this report and is not incorporated by reference herein. We make available free of charge on our website or provide a link on our website to our Annual Report on Form 10‑K, Quarterly Reports on Form 10‑Q and Current Reports on Form 8‑K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after those reports are electronically filed with, or furnished to, the SEC. To access these filings, go to the “Investor Resources” section of our website and then click on “SEC Filings.” You may also read and copy any document we file with the SEC at the SEC’s public reference room located at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at 1‑800‑SEC‑0330 for further information on the public reference room. In addition, these reports and the other documents we file with the SEC are available at a website maintained by the SEC at http://www.sec.gov.
ITEM 1A. RISK FACTORS
Summary of Risks
Our businesses are subject to a number of inherent risks. We believe that the primary risks affecting our businesses and an investment in our shares are:
a complex regulatory and tax environment involving rules and regulations (both domestic and foreign), some of which are outdated relative to today’s complex financial activities and some of which are subject to political influence, which could restrict or require us to adjust our operations or the operations of our funds or portfolio companies and subject us to increased compliance costs and administrative burdens, as well as restrictions on our business activities;
poor performance by our funds due to market conditions, political actions or environments, monetary and fiscal policy or other conditions beyond our control;
the reputational harm that we would experience as a result of inappropriately addressing conflicts of interest, poor performance by the investments we manage or the actual or alleged failure by us, our employees, our funds or our portfolio companies to comply with applicable regulations in an increasingly complex political and regulatory environment;
potential variability in our period to period earnings due primarily to mark‑to‑market valuations of our funds’ investments. As a result of this variability, the market price of our common shares may be volatile and subject to fluctuations; the increasing demands of the investing community, includingAIFMD II has the potential for fee compression and changes to other terms, which could materially adversely affect our revenues; and
an investment in our shares is not an investment in our underlying funds. Moreover, there can be no assurance that projections respecting performance of our underlying funds or unrealized values will be achieved.
Risks Related to Our Businesses
Difficult market and political conditions may adversely affect our businesses in many ways, including by reducing the value or hampering the performance of the investments made by our funds or reducing the ability of our funds to raise or deploy capital, each of which could materially reduce our revenue, net income and cash flow and adversely affect our financial prospects and condition.
Our businesses are materially affected by conditions in the global financial markets and economic and political conditions throughout the world, such as interest rates, the availability and cost of credit, inflation rates, economic uncertainty, changes in laws (including laws relating to our taxation, taxation of our investors and the possibility of changes to regulations applicable to alternative asset managers), trade barriers, commodity prices, currency exchange rates and controls and national and international political circumstances (including wars, terrorist acts and security operations). These factors are outside of our control and may affect the level and volatility of securities prices and the liquidity and value of investments, and we may not be able to or may choose not to manage our exposure to these conditions.
Global financial markets have experienced heightened volatility in recent periods, including as a result of economic and political events in or affecting the world’s major economies. For example, the decision of the People’s Bank of China in January 2016 to reduce the foreign exchange value of the renminbi and subsequent slowdown in China’s industrial sector, the June 2016 referendum in the UK in favor of exiting the EU and subsequent uncertainty regarding the timing and terms of the exit, the 2016 U.S. presidential and congressional election and resulting uncertainty regarding potential shifts in U.S. and foreign, trade, economic and other policies, and, more recently, concerns over increasing interest rates (particularly short-term rates) and uncertainty regarding the short- and long-term effects of tax reform in the United States, have precipitated market volatility. In addition, numerous structural dynamics and persistent market trends have exacerbated volatility generally. Concerns over significant declines in the commodities markets, the implementation by central banks of synchronized global monetary tightening, sluggish economic expansion in non-U.S. economies, including continued concerns over growth prospects in China and emerging markets, growing debt loads for certain countries and uncertainty about the consequences of the U.S. and other governments withdrawing monetary stimulus measures all highlight the fact that economic conditions remain unpredictable and volatile. As a result, although global economies experienced widespread growth in 2017, there is a high risk of significant ongoing volatility. Moreover, there is a risk of both sector-specific and broad based corrections and/or downturns in the equity and credit markets. For example, in February 2018, global equity markets experienced a widespread sell-off, and bonds have also declined in value. Any of the foregoing could
have a significant impact on the markets in which we operate and a material adverse impact on our business prospects and financial condition.
Further, the transition of leadership following the 2016 U.S. presidential and congressional elections, the current U.S. political environment and the resulting uncertainties regarding actual and potential shifts in U.S. foreign, trade, economic and other policies under the new administration have led to further disruption, instability and volatility in the global markets. There can be no assurance these market conditions will not continue or worsen in the future.
A number of factors have had and may continue to have an adverse impact on credit markets in particular. The weakness and the uncertainty regarding the stability of the oil and gas markets resulted in a tightening of credit across multiple sectors. The low price of oil increased default risk among borrowers that have exposure to the energy sector. In addition, following a sustained period of historically low interest rate levels, the Federal Reserve has raised the federal funds rate on multiple occasions since December 2015. Short-term interest rates have risen by 90 to 120 basis points (bps) since the U.S. presidential election in November 2016, with 10 to 20 bps of such amount attributable to increases seen between January 1, 2018 and February 8, 2018. Changes in and uncertainty surrounding interest rates may have a material effect on our business, particularly with respect toincrease the cost and availabilitycomplexity of financing for significant acquisitionraising capital and disposition transactions. Furthermore, someconsequently may slow the pace of fundraising. It is not yet clear to what extent (if any) the U.K. will seek to reflect AIFMD II in its domestic rules implementing AIFMD.
Certain of the provisions underjurisdiction specific private placement regimes may cease to exist if the newly enacted tax law in the United States, Public Law No. 115-97 (the “Tax Cuts and Jobs Act”)non-EEA AIFM passport becomes available. This development could have a negative impact on the cost of financing and dampen the attractiveness of credit. Moreover, while conditions in the U.S. economy have generally improved since the credit crisis, many other economies continue to experience weakness, tighter credit conditions and a decreased availability of foreign capital. Since credit represents a significant portion of our business and ongoing strategy, any of the foregoing could have a material adverse impact on our business prospects and financial condition.
These and other conditions in the global financial markets and the global economy have resulted in, and may continue to result in, adverse consequences for us and many of our funds, each of which could adversely affect the business of such funds, restrict such funds’ investment activities, impede such funds’ ability to effectively achieve their investment objectives and result in lower returns than we anticipated at the time certain of our investments were made. More specifically, these economic conditions could adversely affect our operating results by causing:
decreases in the market value of securities, debt instruments or investments held by some of our funds;
illiquidity in the market, which could adversely affect transaction volumes and the pace of realization of our funds’ investments or otherwise restrict the ability of our funds to realize value from their investments, thereby adversely affecting our ability to generate incentive or other income;
our assets under management to decrease, thereby lowering a portion of our management fees payable by our funds to the extent they are based on market values; and
increases in costs or reduced availability of financial instruments that finance our funds.
During periods of difficult market conditions or slowdowns (which may be across one or more industries, sectors or geographies), companies in which we invest may experience decreased revenues, financial losses, credit rating downgrades, difficulty in obtaining access to financing and increased funding costs. During such periods, these companies may also have difficulty in expanding their businesses and operations and be unable to meet their debt service obligations or other expenses as they become due, including expenses payable to us. Negative financial results in our funds’ portfolio companies may reduce the value of our portfolio companies, the net asset value of our funds and the investment returns for our funds, which could have a material adverse effect on our operating results and cash flow. In addition, such conditions would increase the risk of default with respect to credit-oriented or debt investments. Our funds may be adversely affected by reduced opportunities to exit and realize value from their investments, by lower than expected returns on investments made prior to the deterioration of the credit markets and by our inability to find suitable investments for the funds to effectively deploy capital, which could adversely affect our ability to raise new funds and thus adversely impact our prospects for future growth.
Political and regulatory conditions, including the effects of negative publicity surrounding the financial industry in general and proposed legislation, could adversely affect our businesses or cause a material increase in our tax liability.
As a result of market disruptions and highly publicized financial scandals in recent years, regulators and investors have exhibited concerns over the integrity of the U.S. financial markets, and the businesses in which we operate both in the United States and outside the United States will be subject to new or additional regulations. We may be adversely affected as a result of new or revised legislation or regulations imposed by the SEC, the CFTC or other U.S. governmental regulatory authorities or self-
regulatory organizations that supervise the financial markets. We may also be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental authorities and self-regulatory organizations. See “-Regulatory changes and other developments in the United States and regulatory compliance failures could adversely affect our reputation, businesses and operations.”
Her Majesty’s Treasury (“HM Treasury”), the Organization for Economic Co-operation and Development (the “OECD”) and other government agencies in jurisdictions where we and our affiliates invest or conduct business have maintained a focus on issues related to the taxation of businesses, including multinational entities.
In the United Kingdom, the UK Criminal Finances Act 2017 creates two new separate corporate criminal offences: failure to prevent facilitation of UK tax evasion and failure to prevent facilitation of overseas tax evasion. The scope of the new law and guidance is extremely wide and could have an impact on Ares’ global businesses. Liability can be mitigated where the relevant business has in place reasonable prevention procedures. Separately, the United Kingdom has implemented transparency legislation that will require many large businesses to publish their UK tax strategies on their websites. As part of the publication requirement, organizations must disclose information on tax risk management and governance, tax planning, tax risk appetite and their approach to Her Majesty’s Revenue and Customs. These developments show that the United Kingdom is seeking to bring corporate tax matters further into the public domain. As a result, tax matters may pose an increased reputational risk to our business.
The OECD, which represents a coalition of member countries, has issued guidance through its Base Erosion and Profit Shifting (“BEPS”) project that contemplates changes to long standing international tax norms that determine each country’s jurisdiction to tax cross-border trade and profits. Several of the proposed measures, including measures covering treaty abuse, the deductibility of interest expense, local nexus requirements, transfer pricing and hybrid mismatch arrangements are potentially relevant to some of our structures and could have an adverse tax impact on our funds, investors and/or our portfolio companies. In June 2017, almost 70 countries (excluding the United States) formally signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the “Convention”). These changes in law or guidance and additional proposals for reform, if enacted by the United States or by other countries in which we or our affiliates invest or conduct business, could adversely affect our investment returns, including, for example, by eliminating certain tax treaty benefits and increasing our tax compliance costs. Whether these or other proposals will be enacted by the United States or any foreign jurisdiction and in what form is unknown, as are the ultimate consequences of any such proposed legislation. See “-Risks Related to Taxation.”
Newly enacted laws, such as Tax Cuts and Jobs Act, or regulations and future changes in the U.S. taxation of businesses may impact our effective tax rate or may adversely affect our business, financial condition and operating results.
On December 22, 2017, the President signed into law the Tax Cuts and Jobs Act, which significantly changed the Code, including a reduction in the statutory corporate income tax rate to 21%, a new limitation on the deductibility of business interest expense, restrictions on the use of net operating loss carryforwards arising in taxable years beginning after December 31, 2017 and dramatic changes to the taxation of income earned from foreign sources and foreign subsidiaries. The Tax Cuts and Jobs Act also authorizes the Treasury Department to issue regulations with respect to the new provisions. We cannot predict how the changes in the Tax Cuts and Jobs Act, regulations, or other guidance issued under it or conforming or non-conforming state tax rules might affect us or our business. In addition, there can be no assurance that U.S. tax laws, including the corporate income tax rate, would not undergo significant changes in the near future.
Our business depends in large part on our ability to raise capital from investors. If we were unableEEA investors if, for example, a jurisdiction specific private placement regime ceases to raise such capital, we would be unableoperate and the non-EEA AIFM passport is not made available to collect management fees United States AIFMs.
In addition to the further changes to the AIFMD, a wider review is ongoing which may lead to further changes both under the AIFMD and potentially in other areas of EU regulation, possibly leading to increased costs and/or deploy such capitalburdens and more limit operational flexibility within the EEA and access to EEA investors.
EU measures on the cross-border distribution of investment funds
A new package of measures which will amend the existing regimes governing the cross-border distribution of collective investment funds in the EU (the “CBD Directive” and the “CBD Regulation”) came into investments, which would materially reduce our revenuesforce on August 1, 2019. The changes are largely expected to take effect from August 2, 2021. The CBD Directive and cash flowCBD Regulation amend the existing rules on the distribution of investment funds under AIFMD and adversely affect our financial condition.
Our ability to raise capital from investors depends on a numberThe Undertakings for Collective Investment in Transferable Securities Directive (2009/65/EC). The CBD Directive amends the existing regimes for the cross-border marketing of factors, including many that are outside our control. Investors may downsize their investment allocations to alternative asset managers, including private funds and hedge funds, to rebalance a disproportionate weighting of their overall investment portfolio among asset classes. Poor performance of our funds, or regulatory or tax constraints, could also make it more difficultthe CBD Regulation introduces new standardized requirements for us to raise new capital. Our investors and potential investors continually assess our funds’ performance independently and relative to market benchmarks and our competitors, which affects our ability to raise capital for existing and future funds. If economic and market conditions deteriorate or continue to be so volatile, we may be unable to raise sufficient amounts of capital to support the investment activities of future funds. If we were unable to successfully raise capital, our revenue and cash flow would be reduced, and our financial condition would be adversely affected. Furthermore, while our senior professional owners have committed substantial capital to our funds, commitments from new investors may depend on the commitments made by our senior professional owners to new funds and there can be no assurance that there will be further commitments to our funds, and any future investments by them in our funds or other alternative investment categories will likely depend on the performance of our funds, the performance of their overall investment portfolios and other investment opportunities available to them.
We depend on the Holdco Members, senior professionals and other key personnel, and our ability to retain them and attract additional qualified personnel is critical to our success and our growth prospects.
We depend on the diligence, skill, judgment, business contacts and personal reputations of the Holdco Members, senior professionals and other key personnel. Our future success will depend upon our ability to retain our senior professionals and other key personnel and our ability to recruit additional qualified personnel. These individuals possess substantial experience and expertise in investing, are responsible for locating and executing our funds’ investments, have significant relationships with the institutions that are the source of many of our funds’ investment opportunities and, in certain cases, have strong relationships with our investors. Therefore, if any of our senior professionals or other key personnel join competitors or form competing companies, it could resultcross-border fund distribution in the lossEU. The key changes include a new harmonized “pre-marketing” regime under AIFMD, more transparency and principles for calculating supervisory fees, new procedures for the de-notification of significant investment opportunities, limitmarketing including restrictions on pre-marketing successor funds, regulation of marketing communication as well as additional regulation in relation to reverse solicitation, with further changes expected to follow. The new regulations have the potential to hamper our ability to raise capital from certain existing investors or result in the loss of certain existing investors.
The departure or bad acts for any reason of any of our senior professionals, or a significant number of our other investment professionals, could have a material adverse effect on our ability to achieve our investment objectives, cause certain of our investors to withdraw capital they invest with us or elect not to commit additional capital to our funds or otherwise have a material adverse effect on our business and our prospects. The departure of some or all of those individuals could also trigger certain “key person” provisions in the documentation governing certain of our funds, which would permit the investors in those funds to suspend or terminate such funds’ investment periods or, in the case of certain funds, permit investors to withdraw their capital prior to expiration of the applicable lock-up date. We do not carry any “key person” insurance that would provide us with proceeds in the event of the death or disability of any of our senior professionals, and we do not have a policy that prohibits our senior professionals from traveling together. See “-Employee misconduct could harm us by impairing our ability to attract and retainEEA investors and subjecting us to significant legal liability, regulatory scrutiny and reputational harm.”
We anticipate that it will be necessary for us to add investment professionals both to grow our businesses and to replace those who depart. However, the market for qualified investment professionals is extremely competitive, both in the United States and internationally, and we may not succeed in recruiting additional personnel or we may fail to effectively replace current personnel who depart with qualified or effective successors. Our efforts to retain and attract investment professionals may also result in significant additional expenses, which could adversely affect our profitability or result in an increase in the portion of our performance fees that we grant to our investment professionals. In the year ended December 31, 2017, we incurred equity compensation expenses of $69.7 million, and we expect these costs to continue to increase in the future as we increase the use of equity compensation awards to attract, retain and compensate employees.
Our failure to appropriately address conflicts of interest could damage our reputation and adversely affect our businesses.
As we have expanded and as we continue to expand the number and scope of our businesses, we increasingly confront potential conflicts of interest relating to our funds’ investment activities. Certain of our funds may have overlapping investment objectives, including funds that have different fee structures, and potential conflicts may arise with respect to our decisions regarding how to allocate investment opportunities among those funds. For example, a decision to receive material non-public information about a company while pursuing an investment opportunity for a particular fund may give rise to a potential conflict of interest when it results in our having to restrict the ability of other funds to trade in the securities of such company. We may also cause different Private Equity Group funds to invest in a single portfolio company, for example where the fund that made an initial investment no longer has capital available to invest. We may also cause different funds that we advise to purchase different classes of securities in the same portfolio company. For example, in the normal course of business our Credit Group funds acquire debt positions in companies in which our Private Equity Group funds own common equity securities. A direct conflict of interest could arise between the debt holders and the equity holders if such a company were to develop insolvency concerns. In addition, funds in one group could be restricted from selling their positions in such companies for extended periods because investment professionals in another group sit on the boards of such companies or because another part of the firm has received private information. Certain funds in different groups may invest alongside each other in the same security. On January 18, 2017, ARCC received an order from the SEC that permits ARCC and other business development companies and registered closed-end management investment companies managed by a subsidiary of us to co-invest in portfolio companies with each other and with affiliated investment funds (the “Co-investment Exemptive Order”). The different investment objectives or terms of such funds may result in a potential conflict of interest, including in connection with the allocation of investments between the funds made pursuant to the Co-investment Exemptive Order. In addition, conflicts of interest may exist in the valuation of our investments and regarding decisions about the allocation of specific investment opportunities among us and our funds and the allocation of fees and costs among us, our funds and their portfolio companies.
Though we believe we have appropriate means and oversight to resolve these conflicts, our judgment on any particular allocation could be challenged. While we have developed general guidelines regarding when two or more funds can invest in different parts of the same company’s capital structure and created a process that we employ to handle such conflicts if they arise,
our decision to permit the investments to occur in the first instance or our judgment on how to minimize the conflict could be challenged. If we fail to appropriately address any such conflicts, it could negatively impact our reputation and ability to raise additional funds and the willingness of counterparties to do business with us or result in potential litigation against us.
The investment management business is intensely competitive.
The investment management business is intensely competitive, with competition based on a variety of factors, including investment performance, business relationships, quality of service provided to investors, investor liquidity and willingness to invest, fund terms (including fees), brand recognition and business reputation. We compete with a number of private equity funds, specialized funds, hedge funds, corporate buyers, traditional asset managers, real estate development companies, commercial banks, investment banks, other investment managers and other financial institutions, as well as sovereign wealth funds.
Numerous factors increase our competitive risks, including, but not limited to:
a number of our competitors in some of our businesses have greater financial, technical, marketing and other resources and more personnel than we do;
some of our funds may not perform as well as competitors’ funds or other available investment products;
several of our competitors have raised significant amounts of capital, and many of them have similar investment objectives to ours, which may create additional competition for investment opportunities;
some of our competitors may have a lower cost of capital and access to funding sources that are not available to us, which may create competitive disadvantages for us with respect to our funds, particularly our funds that directly use leverage or rely on debt financing of their portfolio investments to generate superior investment returns;
some of our competitors may have higher risk tolerances, different risk assessments or lower return thresholds than us, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we want to make;
some of our competitors may be subject to less regulation and, accordingly, may have more flexibility to undertake and execute certain businesses or investments than we do and/or bear less compliance expense than we do;
some of our competitors may not have the same types of conflicts of interest as we do;
some of our competitors may have more flexibility than us in raising certain types of funds under the investment management contracts they have negotiated with their investors;
some of our competitors may have better expertise or be regarded by investors as having better expertise in a specific asset class or geographic region than we do;
our competitors that are corporate buyers may be able to achieve synergistic cost savings in respect of an investment, which may provide them with a competitive advantage in bidding for an investment;
our competitors have instituted or may institute low cost high speed financial applications and services based on artificial intelligence and new competitors may enter the asset management space using new investment platforms based on artificial intelligence; and
other industry participants may, from time to time, seek to recruit our investment professionals and other employees away from us.
Developments in financial technology, such as a distributed ledger technology (or blockchain), have the potential to disrupt the financial industry and change the way financial institutions, including investment managers, do business, and could exacerbate these competitive pressures.
We may lose investment opportunities in the future if we do not match investment valuations, structures and terms offered by our competitors. Alternatively, we may experience decreased profitability, rates of return and increased risks of loss if we match investment valuations, structures and terms offered by our competitors. Moreover, if we are forced to compete with other investment
managers on the basis of price when fundraising, we may not be able to maintain our current fund fee and carried interest terms. We have historically competed primarily on the performance of our funds and not on the level of our fees or carried interest relative to those of our competitors. However, there is a risk that fees and carried interest in the investment management industry will decline, without regard to the historical performance of a manager. Fee or carried interest reductions on existing or future funds, without corresponding decreases in our cost structure, would adversely affect our revenues and profitability.
In addition, the attractiveness of investments in our funds relative to other investment products could decrease depending on economic conditions. This competitive pressure could adversely affect our ability to make successful investments and limit our ability to raise future funds, either of which would adversely impact our businesses, revenues, results of operations and cash flow.
Lastly, institutional and individual investors are allocating increasing amounts of capital to alternative investment strategies. Several large institutional investors have announced a desire to consolidate their investments in a more limited number of managers. We expect that this will cause competition in our industry to intensify and could lead to a reduction in the size and duration of pricing inefficiencies that many of our funds seek to exploit.
Poor performance of our funds would cause a decline in our revenue and results of operations, may obligate us to repay performance fees previously paid to us and could adversely affect our ability to raise capital for future funds.
We derive revenues primarily from:
management fees, which are based generally on the amount of capital committed to or invested by our funds;
performance fees, which are based on the performance of our funds; and
returns on investments of our own capital in the funds we sponsor and manage.
When any of our funds perform poorly, either by incurring losses or underperforming benchmarks, as compared to our competitors or otherwise, our investment record suffers. As a result, our performance fees may be adversely affected and, all else being equal, the value of our assets under management could decrease, which may, in turn, reduce our management fees. Moreover, we may experience losses on investments of our own capital in our funds as a result of poor investment performance. If a fund performs poorly, we will receive little or no performance fees with regard to the fund and little income or possibly losses from our own principal investment in such fund. Furthermore, if, as a result of poor performance or otherwise, a fund does not achieve total investment returns that exceed a specified investment return threshold over the life of the fund or other measurement period, we may be obligated to repay the amount by which performance fees that were previously distributed or paid to us exceeds amounts to which we were entitled. Poor performance of our funds could also make it more difficult for us to raise new capital. Investors in our closed-end funds may decline to invest in future closed-end funds we raise as a result of poor performance. Investors in our open-ended funds may redeem their investment as a result of poor performance. Poor performance of our publicly traded funds may result in stockholders selling their stock, thereby causing a decline in the stock price and limiting our ability to access capital. A failure to grow the assets of such funds will limit our ability to earn additional management fees and performance fees, and will ultimately affect our operating results. Our fund investors and potential fund investors continually assess our funds’ performance independently and relative to market benchmarks and our competitors, and our ability to raise capital for existing and future funds and avoid excessive redemption levels depends on our funds’ performance. Accordingly, poor fund performance may deter future investment in our funds and thereby decrease the capital invested in our funds and, ultimately, our management fee income. Alternatively, in the face of poor fund performance, investors could demand lower fees or fee concessions for existing or future funds which would likewise decrease our revenue.
ARCC’s management fee comprises a significant portion of our management fees and a reduction in fees from ARCC could have an adverse effect on our revenues and results of operations.
The management fees we receive from ARCC (including fees attributable to ARCC Part I Fees) comprise a significant percentage of our management fees. The investment advisory agreement we have with ARCC categorizes the fees we receive as: (a) base management fees, which are paid quarterly and generally increase or decrease based on ARCC’s total assets, (b) fees based on ARCC’s net investment income (before ARCC Part I Fees and ARCC Part II Fees), which are paid quarterly (“ARCC Part I Fees”) and (c) fees based on ARCC’s net capital gains, which are paid annually (“ARCC Part II Fees”). We classify the ARCC Part I Fees as management fees because they are paid quarterly, are predictable and recurring in nature, are not subject to repayment (or contingent repayment obligations) and are generally expected to be cash-settled each quarter. If ARCC’s total assets or its net investment income were to decline significantly for any reason, including, without limitation, due to mark-to-market accounting requirements, the poor performance of its investments or the failure to successfully access or invest capital, the amount
of the fees we receive from ARCC, including the base management fee and the ARCC Part I Fees, would also decline significantly and/or may be subject to deferral, which could have an adverse effect on our revenues and results of operations. In addition, because the ARCC Part II Fees are not paid unless ARCC achieves cumulative realized capital gains (net of realized capital losses and unrealized capital depreciation), ARCC’s Part II Fees payable to us are variable and not predictable. We may also, from time to time, waive or voluntarily defer any fees payable by ARCC in connection with strategic transactions.
Our investment advisory and management agreement with ARCC renews for successive annual periods subject to the approval of ARCC’s board of directors or by the affirmative vote of the holders of a majority of ARCC’s outstanding voting securities. In addition, as required by the Investment Company Act, both ARCC and its investment adviser have the right to terminate the agreement without penalty upon 60 days’ written notice to the other party. Termination or non-renewal of this agreement would reduce our revenues significantly and could have a material adverse effect on our financial condition.
We may not be able to maintain our current fee structure as a result of industry pressure from fund investors to reduce fees, which could have an adverse effect on our profit margins and results of operations.
We may not be able to maintain our current fee structure as a result of industry pressure from fund investors to reduce fees. Although our investment management fees vary among and within asset classes, historically we have competed primarily on the basis of our performance and not on the level of our investment management fees relative to those of our competitors. In recent years, however, there has been a general trend toward lower fees in the investment management industry. In September 2009, the Institutional Limited Partners Association (“ILPA”) published a set of Private Equity Principles (the “Principles”) which were revised in January 2011. The Principles were developed to encourage discussion between limited partners and general partners regarding private equity fund partnership terms. Certain of the Principles call for enhanced “alignment of interests” between general partners and limited partners through modifications of some of the terms of fund arrangements, including proposed guidelines for fees and performance income structures. We promptly provided ILPA with our endorsement of the Principles, representing an indication of our general support for the efforts of ILPA. More recently, institutional investors have been increasing pressure to reduce management and investment fees charged by external managers, whether through direct reductions, deferrals, rebates or other means. In addition, we may be asked by investors to waive or defer fees for various reasons, including during economic downturns or as a result of poor performance of our funds. We may not be successful in providing investment returns and service that will allow us to maintain our current fee structure. Fee reductions on existing or future new businesses could have an adverse effect on our profit margins and results of operations. For more information about our fees see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Investors in our funds may be unwilling to commit new capital to our funds because we are a public company, which could have a material adverse effect on our business and financial condition.
Some investors in our funds may have concerns that as a public company our attention is bifurcated between investors in our funds and the public shareholders, resulting in potential conflicts of interest. Some investors in our funds may believe that as a public company we strive for near-term profit instead of superior risk-adjusted returns for investors in our funds over time or grow our assets under management for the purpose of generating additional management fees without regard to whether we believe there are sufficient investment opportunities to effectively deploy the additional capital. There can be no assurance that we will be successful in our efforts to address such concerns or to convince investors in our funds that our status as a public company does not and will not affect our longstanding priorities or the way we conduct our businesses. A decision by a significant number of investors in our funds not to commit additional capital to our funds or to cease doing business with us altogether, or our failure to continue to raise capital, could inhibit our ability to achieve our investment objectives and may have a material adverse effect on our business and financial condition.
Rapid growth of our businesses, particularly outside the United States, may be difficult to sustain and may place significant demands on our administrative, operational and financial resources.
Our assets under management have grown significantly in the past, and we are pursuing further growth in the near future, both organic and through acquisitions. Our rapid growth has placed, and planned growth, if successful, will continue to place, significant demands on our legal, accounting and operational infrastructure, and has increased expenses. The complexity of these demands, and the expense required to address them, is a function not simply of the amount by which our assets under management has grown, but of the growth in the variety and complexity of, as well as the differences in strategy between, our different funds. In addition, we are required to continuously develop our systems and infrastructure in response to the increasing sophistication of the investment management market and legal, accounting, regulatory and tax developments.
Our future growth will depend in part on our ability to maintain an operating platform and management system sufficient to address our growth and will require us to incur significant additional expenses and to commit additional senior management and operational resources. As a result, we face significant challenges:
in maintaining adequate financial, regulatory (legal, tax and compliance) and business controls;
in providing current and future investors with accurate and consistent reporting;
in implementing new or updated information and financial systems and procedures; and
in training, managing and appropriately sizing our work force and other components of our businesses on a timely and cost-effective basis.
We may not be able to manage our expanding operations effectively or be able to continue to grow, and any failure to do so could adversely affect our ability to generate revenue and control our expenses.
In addition, pursuing investment opportunities outside the United States presents challenges not faced by U.S. investments, such as different legal and tax regimes and currency fluctuations, which require additional resources to address. To accommodate the needs of global investors and strategies we must structure investment products in a manner that addresses tax, regulatory and legislative provisions in different, and sometimes multiple, jurisdictions. Further, in conducting business in foreign jurisdictions, we are often faced with the challenge of ensuring that our activities are consistent with U.S. or other laws with extraterritorial application, such as the USA PATRIOT Act and the U.S. Foreign Corrupt Practices Act (the “FCPA”). Moreover, actively pursuing international investment opportunities may require that we increase the size or number of our international offices. Pursuing non-U.S. fund investors means that we must comply with international laws governing the sale of interests in our funds, different investor reporting and information processes and other requirements. As a result, we are required to continuously develop our systems and infrastructure, including employing and contracting with foreign businesses and entities, in response to the increasing complexity and sophistication of the investment management market and legal, accounting and regulatory situations. This growth has required, and will continue to require, us to incur significant additional expenses and to commit additional senior management and operational resources. There can be no assurance that we will be able to manage or maintain appropriate oversight over our expanding international operations effectively or that we will be able to continue to grow this part of our businesses, and any failure to do so could adversely affect our ability to generate revenues and control our expenses.
We may enter into new lines of business and expand into new investment strategies, geographic markets and businesses, each of which may result in additional risks and uncertainties in our businesses.
We intend, if market conditions warrant, growing our businesses by increasing assets under management in existing businesses and expanding into new investment strategies, geographic markets and businesses. Our partnership agreement permits us to enter into new lines of business, make strategic investments or acquisitions and enter into joint ventures. Accordingly, we may pursue growth through acquisitions of other investment management companies, acquisitions of critical business partners or other strategic initiatives, which may include entering into new lines of business. In addition, consistent with our past experience, we expect opportunities will arise to acquire other alternative or traditional asset managers.
Attempts to expand our businesses involve a number of special risks, including some or all of the following:
the required investment of capital and other resources;
the diversion of management’s attention from our core businesses;
the assumption of liabilities in any acquired business;
the disruption of our ongoing businesses;
entry into markets or lines of business in which we may have limited or no experience;
increasing demands on our operational and management systems and controls;
compliance with or applicability to our business or our portfolio companies of regulations and laws, including, in particular, local regulations and laws (for example, consumer protection related laws) and customs in the numerous global jurisdictions in which we operate and the impact that noncompliance or even perceived noncompliance could have on us and our portfolio companies;
potential increase in investor concentration; and
the broadening of our geographic footprint, increasing the risks associated with conducting operations in certain foreign jurisdictions where we currently have no presence.
Entry into certain lines of business may subject us to new laws and regulations with which we are not familiar, or from which we are currently exempt, and may lead to increased litigation and regulatory risk. It could also impact and affect our existing businesses, which might otherwise not be subject to such laws and regulations. If a new business does not generate sufficient revenues or if we are unable to efficiently manage our expanded operations, our results of operations will be adversely affected. Our strategic initiatives may include joint ventures, in which case we will be subject to additional risks and uncertainties in that we may be dependent upon, and subject to liability, losses or reputational damage relating to systems, controls and personnel that are not under our control. Because we have not yet identified these potential new investment strategies, geographic markets or lines of business, we cannot identify all of the specific risks we may face and the potential adverse consequences on us and their investment that may result from any attempted expansion.
If we are unable to consummate or successfully integrate development opportunities, acquisitions or joint ventures, we may not be able to implement our growth strategy successfully.
Our growth strategy is based, in part, on the selective development or acquisition of asset management businesses, advisory businesses or other businesses complementary to our business where we think we can add substantial value or generate substantial returns. The success of this strategy will depend on, among other things: (a) the availability of suitable opportunities, (b) the level of competition from other companies that may have greater financial resources, (c) our ability to value potential development or acquisition opportunities accurately and negotiate acceptable terms for those opportunities, (d) our ability to obtain requisite approvals and licenses from the relevant governmental authorities and to comply with applicable laws and regulations without incurring undue costs and delays, (e) our ability to identify and enter into mutually beneficial relationships with venture partners, (f) our ability to properly manage conflicts of interest and (g) our ability to integrate personnel at acquired businesses into our operations and culture.
This strategy also contemplates the use of our publicly traded common shares as acquisition consideration. Volatility or declines in the trading price of our common shares may make our common shares less attractive to acquisition targets. Moreover, even if we are able to identify and successfully complete an acquisition, we may encounter unexpected difficulties or incur unexpected costs associated with integrating and overseeing the operations of the new businesses. If we are not successful in implementing our growth strategy, our business, financial results and the market price for our common shares may be adversely affected.
Extensive regulation in the United States affects our activities, increases the cost of doing business and creates the potential for significant liabilities and penalties that could adversely affect our businesses and results of operations.so.
Our businesses are subject to extensive regulation, including periodic examinations, by governmental agencies and self-regulatory organizations in the jurisdictions in which we operate. The SEC oversees the activities of our subsidiaries that are registered investment advisers under the Investment Advisers Act. Since the first quarter of 2014, FINRA as well as the SEC has overseen the activities of our wholly owned subsidiary AIS as a registered broker-dealer. We are subject to audits by the Defense Security Service to determine whether we are under foreign ownership, control or influence. In addition, we regularly rely on exemptions from various requirements of the Securities Act, the Exchange Act, the Investment Company Act, the Commodity Exchange Act and the U.S. Employee Retirement Income Security Act of 1974 (“ERISA”). These exemptions are sometimes highly complex and may in certain circumstances depend on compliance by third parties who we do not control. If for any reason these exemptions were to be revoked or challenged or otherwise become unavailable to us, such action could increase our cost of doing business or subject us to regulatory action or third-party claims, which could have a material adverse effect on our businesses. For example, in 2013 the SEC amended Rule 506 of Regulation D under the Securities Act to impose “bad actor” disqualification provisions that ban an issuer from offering or selling securities pursuant to the safe harbor in Rule 506 if the issuer, or any other “covered person,” is the subject of a criminal, regulatory or court order or other “disqualifying event” under the rule which has not been waived by the SEC. The definition of a “covered person” under the rule includes an issuer’s directors, general partners, managing members and executive officers and promoters and persons compensated for soliciting investors in the offering. Accordingly, our ability to rely on Rule 506 to offer or sell securities would be impaired if we or any “covered person” is the subject of a disqualifying event under the rule and we are unable to obtain a waiver or, in certain circumstances, terminate our involvement with such “covered person”.
The SEC has indicated that investment advisors who receive transaction-based compensation for investment banking or acquisition activities relating to fund portfolio companies may be required to register as broker-dealers. Specifically, the SEC staff
has noted that if a firm receives fees from a fund portfolio company in connection with the acquisition, disposition or recapitalization of such portfolio company, such activities could raise broker-dealer concerns under applicable regulations related to broker dealers. If we receive such transaction fees and the SEC takes the position that such activities render us a “broker” under the applicable rules and regulations of the Exchange Act, we could be subject to additional regulation. If receipt of transaction fees from a portfolio company is determined to require a broker-dealer license, receipt of such transaction fees in the past or in the future during any time when we did not or do not have a broker-dealer license could subject us to liability for fines, penalties, damages, rescission or other equitable remedies.
Since 2010, states and other regulatory authorities have begun to require investment managers to register as lobbyists. We have registered as such in a number of jurisdictions, including California, Illinois, New York, Pennsylvania and Kentucky. Other states or municipalities may consider similar legislation or adopt regulations or procedures with similar effect. These registration requirements impose significant compliance obligations on registered lobbyists and their employers, which may include annual registration fees, periodic disclosure reports and internal recordkeeping, and may also prohibit the payment of contingent fees.
Each of the regulatory bodies with jurisdiction over us has regulatory powers dealing with many aspects of financial services, including the authority to grant, and in specific circumstances to cancel, permissions to carry on particular activities. A failure to comply with the obligations imposed by the Investment Advisers Act, including recordkeeping, advertising and operating requirements, disclosure obligations and prohibitions on fraudulent activities, could result in investigations, sanctions and reputational damage. We are involved regularly in trading activities that implicate a broad number of U.S. and foreign securities and tax law regimes, including laws governing trading on inside information, market manipulation and a broad number of technical trading requirements that implicate fundamental market regulation policies. Violation of these laws could result in severe restrictions on our activities and damage to our reputation.
Compliance with existing and new regulations subjects us to significant costs. Moreover, our failure to comply with applicable laws or regulations, including labor and employment laws, could result in fines, censure, suspensions of personnel or other sanctions, including revocation of the registration of our relevant subsidiaries as investment advisers or registered broker-dealers. The regulations to which our businesses are subject are designed primarily to protect investors in our funds and to ensure the integrity of the financial markets. They are not designed to protect our shareholders. Even if a sanction is imposed against us, one of our subsidiaries or our personnel by a regulator for a small monetary amount, the costs incurred in responding to such matters could be material, the adverse publicity related to the sanction could harm our reputation, which in turn could have a material adverse effect on our businesses in a number of ways, making it harder for us to raise new funds and discouraging others from doing business with us.
In the past several years, the financial services industry, and private equity in particular, has been the subject of heightened scrutiny by regulators around the globe. In particular, the SEC and its staff have focused more narrowly on issues relevant to alternative asset management firms, including by forming specialized units devoted to examining such firms and, in certain cases, bringing enforcement actions against the firms, their principals and employees. In recent periods there have been a number of enforcement actions within the industry, and it is expected that the SEC will continue to pursue enforcement actions against private fund managers. This increased enforcement activity may cause us to reevaluate certain practices and adjust our compliance control function as necessary and appropriate.
While the SEC’s recent list of examination priorities includes such items as cybersecurity compliance and controls and conducting risk-based examinations of never-before-examined investment advisory firms, it is generally expected that the SEC’s oversight of alternative asset managers will continue to focus substantially on concerns related to transparency and investor disclosure practices. Although the SEC has cited improvements in disclosures and industry practices in this area, it has also indicated that there is room for improvement in particular areas, including fees and expenses (and the allocation of such fees and expenses) and co-investment practices. To this end, many firms have received inquiries during examinations or directly from the SEC’s Division of Enforcement regarding various transparency-related topics, including the acceleration of monitoring fees, the allocation of broken-deal expenses, the disclosure of operating partner or operating executive compensation, outside business activities of firm principals and employees, group purchasing arrangements and general conflicts of interest disclosures. In addition, our Private Equity Group funds have engaged in the past and may engage from time to time advisors who often work with our investment teams during due diligence, provide board-level governance and support and advise portfolio company leadership. Advisors generally are third parties and typically retained by us pursuant to consulting agreements. In some cases, an operating executive may be retained by a portfolio company directly and in such instances the portfolio company may compensate the operating executive directly (meaning that investors in our Private Equity Group funds may indirectly bear the operating executive’s compensation). While we believe we have made appropriate and timely disclosures regarding the engagement and compensation of these advisors, the SEC staff may disagree.
Regulations governing ARCC’s operation as a business development company affect its ability to raise, and the way in which it raises, additional capital.
As a business development company, ARCC operates as a highly regulated business within the provisions of the Investment Company Act. Many of the regulations governing business development companies have not been modernized within recent securities laws amendments and restrict, among other things, leverage incurrence, co-investments and other transactions with other entities within the Ares Operating Group. Certain of our funds may be restricted from engaging in transactions with ARCC and its subsidiaries.
As a business development company registered under the Investment Company Act, ARCC may issue debt securities or preferred stock and borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the Investment Company Act. Under the provisions of the Investment Company Act, ARCC is permitted, as a business development company, to incur indebtedness or issue senior securities only in amounts such that its asset coverage, as calculated pursuant to the Investment Company Act, equals at least 200% after each such incurrence or issuance. If the value of its assets declines, it may be unable to satisfy this test. If that happens, it may be required to sell a portion of its investments and, depending on the nature of its leverage, repay a portion of its indebtedness at a time when such sales may be disadvantageous. Business development companies may issue and sell common stock at a price below net asset value per share only in limited circumstances, one of which is during an approximately one-year period after obtaining stockholder approval for such issuance in accordance with the Investment Company Act. ARCC’s stockholders have, in the past, approved such issuances so that during the subsequent 12-month period, ARCC may, in one or more public or private offerings of its common stock, sell or otherwise issue shares of its common stock at a price below the then-current net asset value per share, subject to certain conditions including parameters on the level of permissible dilution, approval of the sale by a majority of its independent directors and a requirement that the sale price be not less than approximately the market price of the shares of its common stock at specified times, less the expenses of the sale. ARCC may ask its stockholders for additional approvals from year to year. There can be no assurance that such approvals will be obtained.
Our publicly traded investment vehicles are subject to regulatory complexities that limit the way in which they do business and may subject them to a higher level of regulatory scrutiny.
Our publicly traded investment vehicles operate under a complex regulatory environment. Such companies require the application of complex tax and securities regulations and may entail a higher level of regulatory scrutiny. In addition, regulations affecting our publicly traded investment vehicles generally affect their ability to take certain actions. For example, certain of our publicly traded vehicles have elected to be treated as a REIT or RIC for U.S. federal income tax purposes. To maintain their status as a RIC or a REIT, such vehicles must meet, among other things, certain source of income, asset diversification and annual distribution requirements. ARCC and our publicly traded closed-end fund are subject to complex rules under the Investment Company Act, including rules that restrict certain of our funds from engaging in transactions with ARCC or the closed-end fund. For example, ARCC is required to generally distribute to its stockholders at least 90% of its investment company taxable income to maintain its RIC status and, subject to certain exceptions, ARCC is generally prohibited from issuing and selling its common stock at a price below net asset value per share and from incurring indebtedness (including for this purpose, preferred stock), if ARCC’s asset coverage, as calculated pursuant to the Investment Company Act, equals less than 200% after such incurrence.
Failure to comply with “pay to play” regulations implemented by the SEC and certain states, and changes to the “pay to play” regulatory regimes, could adversely affect our businesses.
In recent years, the SEC and several states have initiated investigations alleging that certain private equity firms and hedge funds or agents acting on their behalf have paid money to current or former government officials or their associates in exchange for improperly soliciting contracts with state pension funds. In June 2010, the SEC approved Rule 206(4)-5 under the Investment Advisers Act regarding “pay to play” practices by investment advisers involving campaign contributions and other payments to government officials able to exert influence on potential government entity clients. Among other restrictions, the rule prohibits investment advisers from providing advisory services for compensation to a government entity for two years, subject to very limited exceptions, after the investment adviser, its senior executives or its personnel involved in soliciting investments from government entities make contributions to certain candidates and officials in a position to influence the hiring of an investment adviser by such government entity. Advisers are required to implement compliance policies designed, among other matters, to track contributions by certain of the adviser’s employees and engagements of third parties that solicit government entities and to keep certain records to enable the SEC to determine compliance with the rule. In addition, there have been similar rules on a state level regarding “pay to play” practices by investment advisers. FINRA recently adopted its own set of “pay to play” regulations, which went into effect on August 20, 2017, that are similar to the SEC’s regulations.
As we have a significant number of public pension plans that are investors in our funds, these rules could impose significant economic sanctions on our businesses if we or one of the other persons covered by the rules make any such contribution or payment, whether or not material or with an intent to secure an investment from a public pension plan. We may also acquire other investment managers who are not subject to the same restrictions as us, but whose activity, and the activity of their principals, prior to our ownership could affect our fundraising. In addition, such investigations may require the attention of senior management and may result in fines if any of our funds are deemed to have violated any regulations, thereby imposing additional expenses on us. Any failure on our part to comply with these rules could cause us to lose compensation for our advisory services or expose us to significant penalties and reputational damage.
The short-term and long-term impact of the Basel III capital standards is uncertain.
In June 2011, the Basel Committee on Banking Supervision, an international trade body comprised of senior representatives of bank supervisory authorities and central banks from 27 countries, including the United States and the EU, announced the final framework for a comprehensive set of capital and liquidity standards, commonly referred to as “Basel III,” for internationally active banking organizations and certain other types of financial institutions. These new standards, which will be fully phased in by 2019, will require banks to hold more capital, predominantly in the form of common equity, than under the current capital framework. Implementation of Basel III will require implementing regulations and guidelines by member countries. In July 2013, the U.S. federal banking regulators announced the adoption of final regulations to implement Basel III for U.S. banking organizations, subject to various transition periods. The EU implemented Basel III in June 2013. In April 2014, U.S. regulators adopted rules requiring enhanced supplementary leverage ratio standards beginning January 1, 2018, which impose capital requirements more stringent than those of the Basel III standards for the most systematically significant banking organizations in the United States. In January 2016, the Basel Committee published its revised capital requirements for market risk, known as Fundamental Review of the Trading Book (“FRTB”), which are expected to generally result in higher global capital requirements for banks that could, in turn, reduce liquidity and increase financing and hedging costs. The impact of FRTB will not be known until after any resulting rules are finalized by the U.S. federal bank regulatory agencies. Compliance with the Basel III standards, the supplemental regulatory standards adopted by U.S. regulators and FRTB may result in significant costs to banking organizations, which in turn may result in higher borrowing costs for the private sector and reduced access to certain types of credit.
Regulatory changes and other developments in the United States and regulatory compliance failures could adversely affect our reputation, businesses and operations.
In July 2010, the Dodd-Frank Act was signed into law and has imposed significant regulations on nearly every aspect of the U.S. financial services industry. The Dodd-Frank Act established a ten voting-member Financial Stability Oversight Council (the “Council”), an interagency body chaired by the Secretary of the Treasury, to identify and manage systemic risk in the financial system and improve interagency cooperation. Under the Dodd-Frank Act, the Council has the authority to review the activities of certain nonbank financial firms engaged in financial activities that are designated as “systemically important,” meaning, among other things, evaluating the impact of the distress of the financial firm on the stability of the U.S. economy. If we were designated as such, it would result in increased regulation of our businesses, including the imposition of capital, leverage, liquidity and risk management standards, credit exposure reporting and concentration limits, restrictions on acquisitions and annual stress tests by the Federal Reserve.
In October 2011, the Federal Reserve and other federal regulatory agencies issued a proposed rule implementing a section of the Dodd-Frank Act that has become known as the “Volcker Rule.” In December 2013, the Federal Reserve and other federal regulatory agencies adopted a final rule implementing the Volcker Rule. The Volcker Rule generally prohibits insured banks or thrifts, any bank holding company or savings and loan holding company, any non-U.S. bank with a U.S. branch, agency or commercial lending company and any subsidiaries and affiliates of such entities, regardless of geographic location, from investing in or sponsoring “covered funds,” which include private equity funds or hedge funds and certain other proprietary activities. The effects of the Volcker Rule are uncertain but it is in any event likely to curtail various banking activities that in turn could result in uncertainties in the financial markets as well as our business. The final Volcker Rule became effective on April 1, 2014, and, except with respect to certain foreign banking entities, the conformance period ended on July 21, 2017. It contains exemptions for certain “permitted activities” that would enable certain institutions subject to the Volcker Rule to continue investing in covered funds under certain conditions. Although we do not currently anticipate that the Volcker Rule will adversely affect our fundraising to any significant extent, there could be adverse implications on our ability to raise funds from the types of entities mentioned above as a result of this prohibition.
Pursuant to the Dodd-Frank Act, regulation of the U.S. derivatives market is bifurcated between the CFTC and the SEC. Under the Dodd-Frank Act, the CFTC has jurisdiction over swaps and the SEC has jurisdiction over security-based swaps. As part of its Dodd-Frank Act related rule-making process, the CFTC made changes to its rules with respect to the registration and oversight
of CPOs. As a result of the CFTC’s revisions to these rules, all swaps (other than security-based swaps) are now included in the definition of commodity interests. As a result, funds that utilize swaps (whether or not related to a physical commodity) as part of their business model may fall within the statutory definition of a commodity pool. If a fund qualifies as a commodity pool, then, absent an available exemption, the operator of such fund is required to register with the CFTC as a CPO. Registration with the CFTC renders such CPO subject to regulation, including with respect to disclosure, reporting, recordkeeping and business conduct, which could significantly increase operating costs by requiring additional resources.
The Dodd-Frank Act requires the CFTC, the SEC and other regulatory authorities to promulgate certain rules relating to the regulation of the derivatives market. Such rules require or will require the registration of certain market participants, the clearing of certain derivatives contracts through central counterparties, the execution of certain derivatives contracts on electronic platforms, as well as reporting and recordkeeping of derivatives transactions. The Dodd-Frank Act also provides expanded enforcement authority to the CFTC and SEC. While certain rules have been promulgated and are already in effect, the rulemaking and implementation process is still ongoing. In particular, the CFTC has finalized most of its rules under the Dodd-Frank Act, and the SEC has proposed a number of rules regarding security-based swaps but has only finalized some of these rules. We cannot therefore yet predict the ultimate effect of the rules and regulations on our business.
Under CFTC and SEC rules, an entity may be required to register as a MSP or MSBSP if it has substantial swaps or security-based swaps positions or has substantial counterparty exposure from its swaps or security-based swaps positions. If any of our funds were required to register as an MSP or MSBSP, it could make compliance more expensive, affect the manner in which we conduct our businesses and adversely affect our profitability. Additionally, if any of our funds qualify as “special entities” under CFTC rules, it could make it more difficult for them to enter into derivatives transactions or make such transactions more expensive.
Pursuant to rules finalized by the CFTC in December 2012 and September 2016, certain classes of interest rate swaps and certain classes of credit default swaps are subject to mandatory clearing, unless an exemption applies. Many of these swaps are also subject to mandatory trading on designated contract markets or swap execution facilities. At this time, the CFTC has not proposed any rules designating other classes of swaps for mandatory clearing, but it may do so in the future. Mandatory clearing and trade execution requirements may change the cost and availability of the swaps that we use, and exposes our funds to the credit risk of the clearing house through which any cleared swap is cleared. In addition, federal bank regulatory authorities and the CFTC have adopted initial and variation margin requirements for swap dealers, security-based swap dealers and swap entities, including permissible forms of margin, custodial arrangements and documentation requirements for uncleared swaps and security-based swaps. As a result, swap entities will be required to collect margin for transactions and positions in uncleared swaps and security-based swaps by financial end users. The new rules became effective for end users on March 1, 2017. The CFTC’s Division of Swap Dealer and Intermediary Oversight subsequently extended, until September 1, 2017 ,the time to comply with the variation margin requirements for swaps that are subject to a March 1, 2017 compliance date. The effect of the regulations on us is not fully known at this time. However, these rules may increase the cost of our activity in uncleared swaps and security-based swaps if we are determined to be a financial end user.
In December 2016, the CFTC re-proposed rules that would set federal position limits for certain referenced contracts, and issued final rules on aggregation among entities under common ownership or control, for position limits on certain futures and options contracts that would apply to the proposed position limits on referenced contracts. It is possible that the CFTC could propose to expand such requirements to other types of contracts in the future. If any when enacted, the proposal could affect our ability and the ability for our funds to enter into derivatives transactions.
The CFTC has finalized rules requiring collateral used to margin cleared swaps to be segregated in a manner different from that applicable to the futures market and has finalized other rules allowing parties to an uncleared swap to require that any collateral posted as initial margin be segregated with a third party custodian. Collateral segregation may impose greater costs on us when entering into swaps.
In addition, the Dodd-Frank Act gave the CFTC expanded anti-fraud and anti-manipulation authority, including authority over disruptive trading practices and insider trading. Several investigations have commenced in the United States related to manipulation of the foreign exchange, LIBOR and indices markets. It is possible that new standards will emerge from these proceedings that could impact the way that we trade.
The Dodd-Frank Act authorizes federal regulatory agencies to review and, in certain cases, prohibit compensation arrangements at financial institutions that give employees incentives to engage in conduct deemed to encourage inappropriate risk-taking by covered financial institutions. In 2016, federal bank regulatory authorities and the SEC revised and re-proposed a rule that generally (1) prohibits incentive-based payment arrangements that are determined to encourage inappropriate risks by certain financial institutions by providing excessive compensation or that could lead to material financial loss and (2) requires
those financial institutions to disclose information concerning incentive-based compensation arrangements to the appropriate federal regulator. The Dodd-Frank Act also directs the SEC to adopt a rule that requires public companies to adopt and disclose policies requiring, in the event the company is required to issue an accounting restatement, the contingent repayment obligations of related incentive compensation from current and former executive officers. The SEC has proposed but not yet adopted such rule. To the extent the aforementioned rules are adopted, our ability to recruit and retain investment professionals and senior management executives could be limited.
The Dodd-Frank Act amends the Exchange Act to compensate and protect whistleblowers who voluntarily provide original information to the SEC and establishes a fund to be used to pay whistleblowers who will be entitled to receive a payment equal to between 10% and 30% of certain monetary sanctions imposed in a successful government action resulting from the information provided by the whistleblower.
The SEC requires investment advisers registered or required to register with the SEC under the Investment Advisers Act that advise one or more private funds and have at least $150.0 million in private fund assets under management to periodically file reports on Form PF. We have filed, and will continue to file, quarterly reports on Form PF, which has resulted in increased administrative costs and requires a significant amount of attention and time to be spent by our personnel.
Many of these provisions are subject to further rulemaking and to the discretion of regulatory bodies, such as the Council and the Federal Reserve. On February 3, 2017, President Trump signed Executive Order 13772 (the “Executive Order”) announcing the new administration’s policy to regulate the U.S. financial system in a manner consistent with certain “Core Principles,” including regulation that is efficient, effective and appropriately tailored. The Executive Order directed the Secretary of the Treasury, in consultation with the heads of the member agencies of the Financial Stability Oversight Council, to report to the President on the extent to which existing laws, regulations and other government policies promote the Core Principles and to identify any laws, regulations or other government policies that inhibit federal regulation of the U.S. financial system.
On June 12, 2017, the U.S. Department of the Treasury (“Treasury”) published the first of several reports in response to the Executive Order on the depository system covering banks and other savings institutions. On October 6, 2017, the Treasury released a second report outlining ways to streamline and reform the U.S. regulatory system for capital markets, followed by a third report, on October 26, 2017, examining the current regulatory framework for the asset management and insurance industries. Subsequent reports are expected to address: retail and institutional investment products and vehicles, as well as non‑bank financial institutions, financial technology and financial innovation.
We may be impacted indirectly by guidance recently directed to regulated banking institutions with regard to leveraged lending practices. In March 2013, the U.S. federal banking agencies issued updated guidance on credit transactions characterized by a high degree of financial leverage. To the extent that such guidance limits the amount or increases the cost of financing we are able to obtain for our transactions, the returns on our investments may suffer. However, the status of the 2013 leveraged lending guidance remains in doubt following a determination by the Government Accountability Office, on October 19, 2017, that such guidance constituted a “rule” for purposes of the Congressional Review Act of 1996. As a result, the guidance was required to be submitted to Congress for review. It is possible the guidance could be overturned if a joint resolution of disapproval is passed by Congress.
On June 8, 2017, the U.S. House of Representatives passed the Financial Choice Act, which includes legislation intended to repeal or replace substantial portions of the Dodd‑Frank Act. Among other things, the proposed law would repeal the Volcker Rule limiting certain proprietary investment and trading activities by banks, eliminate the authority of regulators to designate asset managers and other large non‑bank institutions as “systemically important financial institutions” or “SIFIs,” and repeal the Department of Labor (“DOL”) “fiduciary rule” governing standards for dealing with retirement plans until the SEC issues standards for similar dealings by broker‑dealers and limiting the substance of any subsequent DOL rule to the SEC standards. The bill was referred to the Senate, where it is unlikely to pass as proposed. On November 16, 2017, a bipartisan group of U.S. Senators, led by Senate Banking Committee Chairman, introduced the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Senate Regulatory Relief Bill”). The Senate Regulatory Relief Bill would revise various post-crisis regulatory requirements and provide targeted regulatory relief to certain financial institutions. Among the most significant of its proposed amendments to the Dodd-Frank Act are a substantial increase in the $50 billion asset threshold for automatic regulation of bank holding companies as SIFIs, an exemption from the Volcker Rule for insured depository institutions with less than $10 billion in consolidated assets and lower levels of trading assets and liabilities, as well as amendments to the liquidity leverage ratio and supplementary leverage ratio requirements. On December 5, 2017, the Senate Banking Committee approved the Senate Regulatory Relief Bill. If the legislation is adopted in the Senate, it remains unclear whether and how it would be reconciled with its House-passed counterpart, the Financial Choice Act, which is substantially different in scope and substance, and ultimately approved by both chambers of Congress.
On February 9, 2018, the U.S. Court of Appeals for the District of Columbia ruled that the U.S. Risk Retention Rules do not apply to managers of open-market CLOs (i.e., CLOs for which the underlying assets are not transferred by the manager to the CLO issuer via a sale). The SEC, the Board of Governors of the Federal Reserve System and certain other regulatory agencies have 45 days from the date of the decision to petition the U.S. Court of Appeals for an en banc review, during which time the rule will remain effective. If this petition is not made, or if such petition is made but denied, the U.S. Court of Appeals’ ruling will become effective seven days later with retroactive effect on all existing open-market CLOs. We are in the process of reviewing this decision and its ultimate impact on our business.
It is difficult to determine the full extent of the impact on us of the Financial Choice Act, the Dodd-Frank Act or any other new laws, regulations or initiatives that may be proposed or whether any of the proposals will become law. In addition, as a result of proposed legislation, shifting areas of focus of regulatory enforcement bodies or otherwise, regulatory compliance practices may shift such that formerly accepted industry practices become disfavored or less common. Any changes or other developments in the regulatory framework applicable to our businesses, including the changes described above and changes to formerly accepted industry practices, may impose additional costs on us, require the attention of our senior management or result in limitations on the manner in which we conduct our businesses. Moreover, as calls for additional regulation have increased, there may be a related increase in regulatory investigations of the trading and other investment activities of alternative asset management funds, including our funds. In addition, we may be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental authorities and self-regulatory organizations. Compliance with any new laws or regulations could make compliance more difficult and expensive, affect the manner in which we conduct our businesses and adversely affect our profitability.
Regulatory changes in jurisdictions outside the United States could adversely affect our businesses.
Certain of our subsidiaries operate outside the United States. In the United Kingdom, Ares Management Limited and Ares Management UK Limited are subject to regulation by the FCA. Ares European Loan Management LLP, which is not a subsidiary, but in which we are indirectly invested and which procures certain services from Ares Management Limited, is also subject to regulation by the FCA. In some circumstances, Ares Management Limited, Ares Management UK Limited, Ares European Loan Management LLP and other Ares entities are or become subject to UK or EU laws, for instance in relation to marketing our funds to investors in the EEA.
The UK is scheduled to leave the EU in March 2019. Some form of transitional agreement by which UK based financial services firms can continue to operate on a cross-border basis seems likely. However, the duration of the transitional agreement and the end-state relationship between the UK and EU remains unclear. There is a risk that following Brexit the UK may be denied access to the single market. This could be highly disruptive to our business and may result in us having to increase our presence in other EEA member states which would result in additional costs.
EU legislation could impact our business in the United Kingdom and other EEA member states where we have operations. The following measures are of particular relevance to our business.
In March 2013, the predecessor regulator to the FCA published the final rules for the FCA’s regulation and supervision of the LIBOR. In particular, the FCA’s LIBOR rules include requirements that (1) an independent LIBOR administrator monitor and survey LIBOR submissions to identify breaches of practice standards and/or potentially manipulative behavior, and (2) firms submitting data to LIBOR establish and maintain a clear conflicts of interest policy and appropriate systems and controls. These requirements may cause LIBOR to be more volatile than it has been in the past, which may adversely affect the value of investments made by our funds. On February 3, 2014, ICE Benchmark Administration Limited took responsibility for administering LIBOR, following regulatory authorization by the FCA. LIBOR is expected to be phased out over the coming years. The Bank of England working group has approved SONIA as its preferred short-term interest benchmark and will take over its administration from April 2018. The impact this change will have is uncertain.
The Benchmarks Regulation entered into force on June 30, 2016. It aims to introduce a common framework and consistent approach to benchmark regulation across the EU by regulating producers, contributors to and users of benchmarks. The Benchmarks Regulation will replace the current UK framework regulating LIBOR and other specified benchmarks, notably the EURIBOR. The majority of provisions in the Benchmarks Regulation took effect on January 1, 2018. Although there are measures in the Benchmarks Regulation which are designed to prevent certain benchmarks from being undermined by a material reduction of benchmark contributors, it is not yet clear how successful these will be. The Benchmarks Regulation may therefore lead to unpredictable developments in relation to LIBOR and certain other benchmarks, which could affect the value of investments made by our funds.
The Directive and CRD IV restrict the ability of banks and alternative investment funds (“AIFs”) managed in the EU to invest in securitization vehicles including collateralized loan obligations operated by us unless either the “originator”, “original lender” or “sponsor” (as those terms are defined in the legislation) retains a 5% interest in the securitization concerned. Where such securitization arrangements are managed by Ares-affiliated undertakings, and in order to make the securitization attractive to banks and AIFs, this risk retention requirement is held by an appropriately (EU) authorized and regulated entity affiliated with us (i.e., as “sponsor”). The holding of that retention on our affiliate’s balance sheet is likely to increase that entity’s regulatory capital requirement and will accordingly adversely affect return on equity. On December 28, 2017 the text of the new Securitization Regulation was published in the EU Official Journal. The new regulation will apply from January 1, 2019 to securitization issued after that date. Although risk retention requirements will remain at 5% (of material net economic interest) a mechanism has been introduced whereby this requirement could be modified without the need for the change to be made through the normal EU legislative process. There are also new investor transparency requirements which require additional information to be disclosed to investors. Compliance with these new requirements in the Securitization Regulation may result in us incurring material costs.
The EU Regulation on OTC derivative transactions, central counterparties and trade repositories (commonly known as EMIR) will require the mandatory clearing of certain OTC derivatives through central counterparties and creates additional margining requirements in respect of OTC derivative transactions that are not cleared by a central counterparty. The implementation of EMIR is phased; timing is dependent on the type of derivative and the categorization of the parties to the trade. Implementation deadlines have already been deferred but as they currently stand full implementation is due by July 9, 2019. EMIR has started to impact on Ares-affiliated undertakings and as further implementation dates are reached the cost of complying with the requirements is likely to increase. In addition, there is an amendment to EMIR currently working its way through EU the legislative process. Among other things, the amendment would classify securitization special purpose entities as financial counterparties which may indirectly impact certain aspects of our business.
On December 14, 2015, the European Banking Authority published guidelines which are relevant to, among other things, EU banks' exposures to shadow banking entities. These guidelines have applied since January 1, 2017. The definition of shadow banking entity is extremely wide and could potentially catch a number of different entities, including investment funds and securitization vehicles. AIFs are excluded from the definition of a shadow banking entity unless they: (1) deploy leverage within the meaning of the Directive on a substantial basis; or (2) are permitted to originate loans or purchase third party lending exposures onto their balance sheet pursuant to the relevant fund rules or constitutional documents. These guidelines may affect our ability to raise capital in certain of our funds from EU banks.
On December 20, 2017, the European Commission published a proposal for a new directive and regulation on prudential requirements for MiFID investment firms, and the proposal will directly apply to Ares Management Limited and Ares European Loan Management LLP. Its application to Ares Management UK Limited is unclear. Under the proposals most affected firms would see their capital requirements increase significantly, although there would be transitional provisions allowing firms to increase their capital to the necessary level over three to five years. Firms will also have their liquidity requirements increased and some firms will be subject to additional public reporting requirements and pay regulation. The proposals are likely to increase the cost of us conducting business in the EEA. The legislative package is not expected to come into force until 2020 at the earliest.
Our UK, other European and Asian operations and our investment activities worldwide are subject to a variety of regulatory regimes that vary by country. In addition, we regularly rely on exemptions from various requirements of the regulations of certain foreign countries in conducting our asset management activities.
Each of the regulatory bodies with jurisdiction over us has regulatory powers dealing with many aspects of financial services, including the authority to grant, and in specific circumstances to cancel, permissions to carry on particular activities. We are involved regularly in trading activities that implicate a broad number of foreign (as well as U.S.) securities law regimes, including laws governing trading on inside information and market manipulation and a broad number of technical trading requirements that implicate fundamental market regulation policies. Violation of these laws could result in severe restrictions or prohibitions on our activities and damage to our reputation, which in turn could have a material adverse effect on our businesses in a number of ways, making it harder for us to raise new funds and discouraging others from doing business with us. In addition, increasing global regulatory oversight of fundraising activities, including local registration requirements in various jurisdictions and the addition of new compliance regimes, could make it more difficult for us to raise new funds or could increase the cost of raising such funds.
Alternative Investment Fund Managers Directive
The Directive was enacted in July 2011 and took effect on July 22, 2013. The Directive2013 and applies to (1) AIFMs established in the EEA that manage EEA or non-EEA AIFs, (2) non-EEA AIFMs that manage EEA AIFs and (3) non-EEA AIFMs that market their AIFs to professional investors within the EEA.
Each Non-EEA AIFMs do not currently benefit from marketing passport rights and may only market AIFs to investors in some EEA jurisdictions in accordance with national private placement regimes. The U.K. implemented AIFMD while it was still a member of the AIFMs identified in (1), (2)EU and (3) of the paragraph above needsimilar requirements therefore continue to comply with the Directive’s disclosure and transparency requirements when seeking to market within the EEA and,apply in the case of non-EEA AIFMs seeking to market under jurisdiction specific private placement regimes, additional jurisdiction specific requirements where these exist (e.g., appointing a depositary). However, the full scope of the Directive may also be extended on a jurisdiction-by-jurisdiction basis to non-EEA AIFMs that wish to market an AIF within the EEA pursuant to a pan-European marketing passport. In July 2016, the ESMA published advice to EU institutions on extending the passport to certain non-EU jurisdictions. The European Commission was expected and arguably required to publish legislation before the end of October 2016 setting a date for the pan-European marketing passport to be made available, at least in respect of the five non-EEA jurisdictions it had assessed positively. It did not publish this legislation.U.K. notwithstanding Brexit.
In 2017 the European Commission started a review of the application and scope of AIFMD. The European Commission is expected to makepublished a legislative proposal as a resultreport on the operation of the review (commonly referred to as "AIFMD II") with any changes to non-EEA jurisdiction passporting rights forming part of the proposal. Given that the review ofAIFMD in January 2019, which identified certain areas requiring further analysis. A subsequent report on the application and scope of AIFMD was published in June 2020. Following these reports, the European Commission launched a
public consultation relating to its review of the AIFMD in October 2020 (which closes on 29 January 2021). This is still ongoingexpected to result in a legislative proposal (commonly referred to as “AIFMD II”). AIFMD imposes a range of requirements on AIFMs and “leveling up” of these requirements under AIFMD II seems likely, which may increase the cost of doing business for Ares Management Luxembourg and Ares’ non-EEA AIFMs (including Ares Management UK Limited) wishing to market funds in the EEA and potentially disadvantages our funds as investors in private companies located in EEA member states when compared to non-AIF/AIFM competitors that may not be subject to such requirements. Although the reports and public consultation gives some indication of the direction of travel, the substance of any legislative proposal isremains uncertain and it remainsis unclear whether and how any such legislation couldwill affect us or our subsidiaries. Further, complianceCompliance with AIFMD or AIFMD II mayhas the potential to increase the cost and complexity of raising capital and consequently may slow the pace of fundraising. It is not yet clear to what extent (if any) the U.K. will seek to reflect AIFMD II in its domestic rules implementing AIFMD.
Certain of the jurisdiction specific private placement regimes may cease to exist whenif the non-EEA AIFM passport becomes available. This development could have a negative impact on our ability to raise capital from EEA investors if, for example, a jurisdiction specific private placement regime ceases to operate and the non-EEA AIFM passport is not made available to United States AIFMs.
The operating requirements imposed by In addition to the Directivefurther changes to the AIFMD, a wider review is ongoing which may lead to further changes both under the AIFMD and potentially in other areas of EU regulation, possibly leading to increased costs and/or burdens and more limit operational flexibility within the EEA and access to EEA investors.
EU measures on the categoriescross-border distribution of AIFMDs listedinvestment funds
A new package of measures which will amend the existing regimes governing the cross-border distribution of collective investment funds in (1)the EU (the “CBD Directive” and (2) abovethe “CBD Regulation”) came into force on August 1, 2019. The changes are largely expected to take effect from August 2, 2021. The CBD Directive and CBD Regulation amend the existing rules on the distribution of investment funds under AIFMD and The Undertakings for Collective Investment in Transferable Securities Directive (2009/65/EC). The CBD Directive amends the existing regimes for the cross-border marketing of funds and the CBD Regulation introduces new standardized requirements for cross-border fund distribution in the EU. The key changes include among other things, rules relating toa new harmonized “pre-marketing” regime under AIFMD, more transparency and principles for calculating supervisory fees, new procedures for the remunerationde-notification of certain personnel, minimum regulatory capital requirements,marketing including restrictions on pre-marketing successor funds, regulation of marketing communication as well as additional regulation in relation to reverse solicitation, with further changes expected to follow. The new regulations have the use of leverage, restrictions on early distributions relatingpotential to portfolio companies (so-called “asset stripping rules”), disclosure and reporting requirementshamper our ability to bothraise capital from EEA investors and home state regulators, the independent valuation of an AIF’s assets and the appointment of an independent depository to hold assets. As a result, the Directive increases the regulatory burden andincrease the cost of doing business for Ares Management UK Limited and, to a more limited extent, non-EEA AIFMs which market non-EEA AIFs under EEA private placement regimes. This potentially disadvantages our funds as investors in private companies located in EEA member states when compared to non-AIF/AIFM competitors that may not be subject to the requirements of the Directive, thereby potentially restricting our funds’ ability to invest in such companies. “Levelling-up” of some of these requirements seems likely under AIFMD II.
The Directive could also limit our operating flexibility and our investment opportunities, as well as expose us and/or our funds to conflicting regulatory requirements in the United States and elsewhere.so.
Solvency II
Solvency II sets out stronger capital adequacy and risk management requirements for European insurers and reinsurers and, in particular, dictates how much capital such firms must hold against their liabilities and introduces a risk-based assessment of those liabilities. Solvency II came into force on January 1, 2010 but was only required to be implemented by firms on January 1, 2016. There are also a number of transitional provisions designed to avoid market disruption. Solvency II imposes, among other things, substantially greater quantitative and qualitative capital requirements for insurers and reinsurers as well as other supervisory and disclosure requirements. We are not subject to Solvency II; however, many of our European insurer or reinsurer fund investors are subject to this directive, as applied under applicable domestic law. Solvency II may impact insurers’ and reinsurers’ investment decisions and their asset allocations. In addition, insurers and reinsurers will be subject to more onerous data collation and reporting requirements. As a result, Solvency II could have an adverse indirect effect on our businesses by, among other things, restricting the ability of European insurers and reinsurers to invest in our funds and imposing on us extensive disclosure and reporting obligations for those insurers and reinsurers that do invest in our funds. A numberbroad review of reviews ofSolvency II was carried out by the European Commission in 2020 (the “Solvency II 2020 review”), with input from the European Insurance and Occupational Pensions Authority (“EIOPA”). This included a related public consultation launched by the European Commission in July 2020. On December 17, 2020, EIOPA submitted its opinion on the Solvency II 2020 review to the European Commission. The Solvency II 2020 review is expected to result in amendments to various aspects and components of Solvency II, are expected throughout 2018.although the extent of such amendments is as yet unknown.
MiFID II
The recast Markets in Financial Instruments Directive and Markets in Financial Instruments Regulation (collectively referred to as MiFID II)“MiFID II”) came into effect on January 3, 2018. MiFID II amendsamended the existing MiFID regime and, among other requirements, introducesintroduced new organizational and operationalconduct of business requirements for investment firms in the EEA. MiFID II requirements apply to Ares Management Limited and Ares European Loan Management LLP as MiFID investment firms. Certain requirements of MiFID II also apply to AIFMs with a MiFID “top-up” permission, such as Ares Management UK Limited and Ares Management Luxembourg.
MiFID II extended MiFID requirements in a number of areas such as the receipt and payment of inducements (including investment research), suitability and appropriateness assessments, conflicts of interest, record-keeping, costs and charges disclosures, best execution, product design and governance, and transaction and trade reporting. Under MiFID II, national competent authorities (including the FCA), within EU member states, are also required to establish position limits in relation to the maximum size of positions which a relevant person can hold in certain commodity derivatives. The limits apply to contracts traded on trading venues and their economically equivalent OTC contracts. The position
limits established, as amended from time to time, and our ability to rely on any exemption thereunder may affect the size and types of investments we may make. Moreover,Failure to comply with MiFID II and its associated legislative acts could result in ordersanctions from national regulators, the loss of market access and a number of other adverse consequences which would have a detrimental impact on our business.
Although the U.K. has now withdrawn from the EU, its rules implementing the recast Markets in Financial Instruments Directive continue to avoid exceeding position limits,have effect and the Markets in Financial Instruments Regulation has been on-shored into U.K. law (subject to certain amendments to ensure it operates properly in a U.K.-specific context) in connection with such withdrawal.
CSPD
In March 2018, the European Commission published a proposal for a new directive governing credit servicers, credit purchasers and the recovery of collateral in connection with loans (the “Credit Servicers and Purchasers Directive” or “CSPD”). The policy aim behind CSPD is the development of a well-functioning secondary market for non-performing loans. The original European Commission legislative proposal contemplated most national law provisions transposing CSPD coming into effect from January 1, 2021. However, this original proposal is still working its way through the legislative process and it is possibletherefore currently unclear when CSPD will be published, let alone scheduled for implementation.
As proposed by the European Commission, the CSPD would apply to, among others, “credit servicers” and “credit purchasers” and would impose a number of new requirements relating to licensing, conduct of business and provision of information.
The definition of “credit servicer” in the Commission proposal is sufficiently broad that weit could be construed to include asset managers. However, the proposal limits the scope of the requirements for credit servicers and our affiliatescredit purchasers to the servicing or purchasing of credit agreements originally issued by a credit institution established in the EU or its subsidiaries established in the EU. This means that the servicing of loans originally advanced by credit funds (rather than, for example, an EU bank) will fall outside the scope of the CSPD as currently proposed. Asset managers are unlikely to act as principal credit purchasers. However, they may needpurchase in-scope credit agreements as agent on behalf of the funds or segregated managed accounts for whom they are acting and therefore may in practice be required to significantly alter our business processes related to such trading, including by modifying trading strategies and instructions.
discharge the associated obligations on behalf of underlying clients. Compliance with these rules requires updatescould involve a material cost to some existing procedures, systemsour business.
Hong Kong Security Law.
On June 30, 2020, the National People’s Congress of China passed a national security law (the “National Security Law”), which criminalizes certain offenses including secession, subversion of the Chinese government, terrorism and controlscollusion with foreign entities. The National Security Law also applies to non-permanent residents. Although the extra-territorial reach of the National Security Law remains unclear, there is a risk that the application of the National Security Law to conduct outside Hong Kong by non-permanent residents of Hong Kong could limit the activities of or negatively affect the Company, our investment funds and/or portfolio companies. The National Security Law has been condemned by the United States, the United Kingdom and the developmentseveral EU countries. The United States and other countries may take action against China, its leaders and leaders of new internal systems,Hong Kong, which may include substantial automatedthe imposition of sanctions. Escalation of tensions resulting from the National Security Law, including conflict between China and electronic systems,other countries, protests and is likelyother government measures, as well as other economic, social or political unrest in the future, could adversely impact the security and stability of the region and may have a material adverse effect on countries in which the Company, our investment funds and portfolio companies or any of their respective personnel or assets are located. In addition, any downturn in Hong Kong’s economy could adversely affect the financial performance of the Company and our investments, or could have a significant impact on the industries in which the Company participates, and may adversely affect the operations of the Company, its investment funds and portfolio companies, including the retention of investment and other key professionals located in Hong Kong.
Regulations governing ARCC’s operation as a business development company affect its ability to involve material costsraise, and the way in which it raises, additional capital.
As a business development company, ARCC operates as a highly regulated business within the provisions of the Investment Company Act. Many of the regulations governing business development companies restrict, among other things, leverage incurrence, co-investments and other transactions with other entities within the Ares Operating Group. Certain of our funds may be restricted from engaging in transactions with ARCC and its subsidiaries. As a business development company
registered under the Investment Company Act, ARCC may issue debt securities or preferred stock and borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the business.maximum amount permitted by the Investment Company Act. Under the provisions of the Investment Company Act, ARCC is currently permitted, as a business development company, to incur indebtedness or issue senior securities only in amounts such that its asset coverage, as calculated pursuant to the Investment Company Act, equals at least 150% after giving effect to such incurrence or issuance. On March 23, 2018, the Small Business Credit Availability Act (“SBCAA”) was signed into law. The SBCAA, among other things, modified the applicable provisions of the Investment Company Act to reduce the required asset coverage ratio applicable to business development companies from 200% to 150% subject to certain approval, time and disclosure requirements (including either stockholder approval or approval of a “required majority” of its board of directors). On June 21, 2018, ARCC’s board of directors, including a “required majority” of its board of directors, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the Investment Company Act, as amended by the SBCAA. As a result, effective on June 21, 2019, ARCC’s asset coverage requirement applicable to senior securities was reduced from 200% to 150%.
Business development companies may issue and sell common stock at a price below net asset value per share only in limited circumstances, one of which is after obtaining stockholder approval for such issuance in accordance with the Investment Company Act. ARCC’s stockholders have, in the past, approved such issuances so that during the subsequent 12-month period, ARCC may, in one or more public or private offerings of its common stock, sell or otherwise issue shares of its common stock at a price below the then-current net asset value per share, subject to certain conditions including parameters on the amount of shares sold, approval of the sale by the directors and a requirement that the sale price be not less than approximately the market price of the shares of its common stock at specified times, less the expenses of the sale. ARCC may ask its stockholders for additional approvals from year to year. There can be no assurance that such approvals will be obtained.
The votepublicly traded investment vehicles that we manage are subject to regulatory complexities that limit the way in which they do business and may subject them to a higher level of regulatory scrutiny.
The publicly traded investment vehicles that we manage operate under a complex regulatory environment. Such companies require the application of complex tax and securities regulations and may entail a higher level of regulatory scrutiny. In addition, regulations affecting our publicly traded investment vehicles generally affect their ability to take certain actions. For example, certain of our publicly traded vehicles have elected to be treated as a RIC or a REIT for U.S. federal income tax purposes. To maintain their status as a RIC or a REIT, such vehicles must meet, among other things, certain source of income, asset diversification and annual distribution requirements. ARCC is required to generally distribute to its stockholders at least 90% of its investment company taxable income to maintain its RIC status. ARCC and our publicly traded closed-end fund are subject to complex rules under the Investment Company Act, including rules that restrict certain of our funds from engaging in transactions with ARCC or the closed-end fund. In addition, subject to certain exceptions, ARCC is generally prohibited from issuing and selling its common stock at a price below net asset value per share and from incurring indebtedness (including for this purpose, preferred stock), if ARCC’s asset coverage, as calculated pursuant to the Investment Company Act, equals less than 150% after giving effect to such incurrence.
Failure to comply with “pay to play” regulations implemented by the SEC and certain states, and changes to the “pay to play” regulatory regimes, could adversely affect our businesses.
In recent years, the SEC and several states have initiated investigations alleging that certain private equity firms and hedge funds or agents acting on their behalf have paid money to current or former government officials or their associates in exchange for improperly soliciting contracts with state pension funds. Under SEC rules addressing “pay to play” practices, investment advisers are prohibited from providing advisory services for compensation to a government entity for two years, subject to very limited exceptions, after the investment adviser, its senior executives or its personnel involved in soliciting investments from government entities make contributions to certain candidates and officials in a position to influence the hiring of an investment adviser by such government entity. Advisers are required to implement compliance policies designed, among other matters, to track contributions by certain of the adviser’s employees and engagements of third parties that solicit government entities and to keep certain records to enable the SEC to determine compliance with the rule. In addition, there have been similar rules on a state level regarding “pay to play” practices by investment advisers. FINRA adopted its own set of “pay to play” regulations, which went into effect on August 20, 2017, that are similar to the SEC’s regulations.
As we have a significant number of public pension plans that are investors in our funds, these rules could impose significant economic sanctions on our businesses if we or one of the other persons covered by the rules make any such contribution or payment, whether or not material or with an intent to secure an investment from a public pension plan. We may also acquire other investment managers or hire additional personnel who are not subject to the same restrictions as us, but whose activity, and the activity of their principals, prior to our ownership or employment of such person could affect our fundraising. In addition, such investigations may require the attention of senior management and may result in fines if any of
our funds are deemed to have violated any regulations, thereby imposing additional expenses on us. Any failure on our part to comply with these rules could cause us to lose compensation for our advisory services or expose us to significant penalties and reputational damage.
Adverse incidents with respect to ESG activities could impact our or our portfolio companies’ reputation, the cost of our or their operations, or result in investors ceasing to allocate their capital to us, all of which could adversely affect our business and results of operations.
We, our funds and their portfolio companies face increasing public scrutiny related to ESG activities. We and they risk damage to our brand and reputation, if we or they fail to act responsibly in a number of areas, such as diversity, equity and inclusion, environmental stewardship, support for local communities, corporate governance and transparency and considering ESG factors in our investment processes. Adverse incidents with respect to ESG activities could impact the value of our brand, or the brand of our funds or their portfolio companies, the cost of our or their operations and relationships with investors, all of which could adversely affect our business and results of operations.
Additionally, new regulatory initiatives related to ESG that are applicable to us, our funds and their portfolio companies could adversely affect our business. In May 2018, the European Commission adopted an “action plan on financing sustainable growth.” The action plan is, among other things, designed to define and reorient investment toward sustainability. The action plan contemplates: establishing EU labels for green financial products; clarifying asset managers' and institutional investors' duties regarding sustainability in their investment decision-making processes; increasing disclosure requirements in the UKfinancial services sector around ESG and strengthening the transparency of companies on their ESG policies and introducing a ‘green supporting factor’ in the EU prudential rules for banks and insurance companies to incorporate climate risks into banks’ and insurance companies’ risk management policies.
A number of these initiatives are underway and on December 9, 2019, Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial sector was published in the Official Journal of the European Union (the “Sustainable Finance Disclosure Regulation” or “SFDR”). SFDR introduces mandatory sustainability-related transparency requirements for MiFID investment firms providing portfolio management or investment advisory services, and AIFMs. Broadly, SFDR will require such firms to make disclosures on their website and pre-contractual disclosures including (but not limited to) information on how sustainability risks are integrated into the firm’s investment decisions (or advice). Firms that offer financial products (such as AIFs) that promote environmental or social characteristics, or which have a sustainable investment objective, will also need to comply with additional disclosure and periodic reporting requirements that are broadly designed to prevent firms from “greenwashing” (i.e., the holding out of a product as having green or sustainable characteristics where this is not, in fact, the case). There is a risk that a significant reorientation in the market following the implementation of these and further measures could be adverse to our portfolio companies if they are perceived to be less valuable as a consequence of, among other things, their carbon footprint or “greenwashing.” The majority of the requirements of SFDR will apply from March 10, 2021.
In addition, on June 22, 2020, Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment was published in the Official Journal of the European Union (the “Taxonomy Regulation”). The Taxonomy Regulation sets out a framework for classifying economic activities as “environmentally sustainable” and also introduces certain mandatory disclosure and reporting requirements (which supplement those set out in SFDR) for financial products which have an environmental sustainable investment objective or which promote environmental characteristics. The Taxonomy Regulation is due to take effect in part from January 2022 and in part from January 2023.
Much of the detail surrounding these EU sustainable finance initiatives is yet to be revealed and has been further delayed by the COVID-19 pandemic so it is not possible at this stage to fully assess how our business will be affected. We, our funds and their portfolio companies are subject to the risk that similar measures might be introduced in other jurisdictions in which we or they currently have investments or plan to invest in the future. Additionally, compliance with any new laws or regulations (including recent heightened SEC scrutiny regarding advisor compliance with advisors’ own internal policies) increases our regulatory burden and could make compliance more difficult and expensive, affect the manner in which we, our funds or their portfolio companies conduct our businesses and adversely affect our profitability.
While the U.K. is not expected to implement equivalent legislative initiatives, it has signaled an intention to introduce a new legislative framework focused on implementing the recommendations of the Financial Stability Board Taskforce on Climate-related Financial Disclosures (“TCFD”), in particular by introducing mandatory TCFD-aligned disclosure requirements for U.K. firms. This framework is still in development and will be subject to a phased implementation, meaning it is not expected to begin to apply to the asset management sector until 2022 at the earliest. It is unclear at this stage what impact this new regime will have on our business.
Economic sanction laws in the United States and other jurisdictions may prohibit us and our affiliates from transacting with certain countries, individuals and companies, which could negatively impact our business, financial condition and operating results.
Economic sanction laws in the United States and other jurisdictions may restrict or prohibit us or our affiliates from transacting with certain countries, territories, individuals and entities. In the United States, the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) administers and enforces laws, executive orders and regulations establishing U.S. economic and trade sanctions, which restrict or prohibit, among other things, direct and indirect transactions with, and the provision of services to, certain non-U.S. countries, territories, individuals and entities. These types of sanctions may significantly restrict or completely prohibit lending activities in certain jurisdictions, and if we were to violate any such laws or regulations, we may face significant legal and monetary penalties, as well as reputational damage. OFAC sanctions programs change frequently, which may make it more difficult for us or our affiliates to ensure compliance. Moreover, OFAC enforcement is increasing, which may increase the risk that an issuer or we become subject of such actual or threatened enforcement.
For instance, the Iran Threat Reduction and Syria Human Rights Act of 2012 (the “ITRA”) expanded the scope of U.S. sanctions against Iran. Additionally, Section 219 of the ITRA amended the Exchange Act to require companies subject to SEC reporting obligations under Section 13 of the Exchange Act to disclose in their periodic reports specified dealings or transactions involving Iran or other individuals and entities targeted by certain Office of Foreign Assets Control of the Treasury sanctions engaged in by the reporting company or any of its affiliates during the period covered by the relevant periodic report. In some cases, the ITRA requires companies to disclose these types of transactions even if they were permissible under U.S. law. Companies that currently may be or may have been at the time considered our affiliates have from time to time publicly filed and/or provided to us the disclosures reproduced on Exhibit 99.1 of our Quarterly Reports. We do not independently verify or participate in the preparation of these disclosures. We are required to separately file and have separately filed with the SEC a notice when such activities have been disclosed in this report or in our quarterly reports, and the SEC is required to post such notice of disclosure on its website and send the report to the President and certain U.S. Congressional committees. The President thereafter is required to initiate an investigation and, within 180 days of initiating such an investigation, determine whether sanctions should be imposed. As of December 31, 2020, no sanctions have been imposed on us as a result of our disclosures of these activities. Disclosure of such activity, even if such activity is not subject to sanctions under applicable law, and any sanctions actually imposed on us or our affiliates as a result of these activities, could harm our reputation and have a negative impact on our business, financial condition and results of operations, and any failure to disclose any such activities as required could additionally result in fines or penalties.
The U.K.'s exit from the EU (“Brexit”) could adversely affect our business and our operations.
The vote byU.K. exited the electorate inEuropean Union on January 31, 2020 and a referendum intransitional period of 11 months commenced on this date to allow for the UK to exit from the EU (referred to as “Brexit”) could disrupt our business and operations, including the liquidity and value of our investments. Since its announcement, Brexit has caused significant geo-political uncertainty and market volatility in the UK and elsewhere. Although the referendum is non-binding, the UK’s leadership has indicated that it expects Brexit to be passed into law and to commence negotiationsU.K.’s future relationship with the EU to determinebe negotiated. This transitional period ended on December 31, 2020. Following the end of this transitional period, so-called EEA “passporting rights” facilitating market access into the EEA by U.K. firms, and into the U.K. by EEA firms, are no longer available. Various EU laws have been “on-shored” into domestic U.K. legislation and certain transitional regimes and deficiency-correction powers exist to ease the transition.
The U.K. and the EU announced, in December 2020, that they have reached agreement on a new Trade and Cooperation Agreement (the “TCA”), which addresses the future terms, including with respectrelationship between the parties. The TCA was approved by the U.K. Parliament on December 30, 2020. Due to trade,the TCA only being agreed shortly before the end of the UK’s ongoing relationship withtransition period, it will apply on a provisional basis in the EU. These negotiations are expectedEU until it is formally ratified by the European Parliament. The TCA covers, for example, measures to take a numberpreserve tariff-free trade in goods and the ability of years, which could prolong the related uncertainty and volatility, which among other things, could affect the pace of capital deployment and investment realizations.
Depending on the outcome of these negotiations, the UK could lose accessU.K. nationals to the single EU market andtravel to the global trade deals negotiated by the EU on behalf of its members, which could havebusiness but defers other issues. While the TCA includes a material adverse effect on our operationscommitment by the U.K. and the operations of our portfolio companies. For example,EU to keep their markets open for persons wishing to provide financial services through a declinepermanent establishment, it does not substantively address future cooperation in trade could affect the attractivenessfinancial services sector or reciprocal market access into the EU by U.K. firms under equivalence arrangements. The European Commission has indicated that its assessment of the UKU.K.’s replies to its equivalence enquiries remains ongoing and, at this stage, there is no certainty as a global investment centerto when such assessments will be concluded or whether the U.K. will be deemed equivalent in some or all of the individual assessments.
While the TCA provides clarity in some areas, there remains considerable uncertainty as to the future position of the U.K. and as a result, could make doing business in Europe more difficult.
Currently under the EU single market directives, mutual access rightsarrangements which will apply to markets and market infrastructure exist acrossits relationships with the EU and other countries following the mutual recognitionend of insolvency, bank recovery and resolution regimes applies. In addition,the transitional period. Ares Management Luxembourg was established to enable Ares to continue certain regulated entities licensedactivities in the EU post Brexit. Applicable regulatory requirements may increase effective tax rates within Ares’ structure or authorizedon its investments, including by way of higher levels of tax being imposed on Ares Management Luxembourg and EU branches of Ares Management Luxembourg. As yet, the full impact of Brexit on our business operations in one EEA jurisdictionthe U.K. and the EU, and on the private investment funds industry more broadly, remains uncertain. This is driven in part by the ongoing uncertainty relating to
equivalence and the extent to which the EU will grant reciprocal market access to U.K. firms in the financial sector. It is possible that certain of our funds’ investments may operate onneed to be restructured to enable their objectives fully to be pursued (e.g. because of a cross-border basis in other EEA countries in reliance onloss of passporting rights and without the need for a separate license or authorization. There is uncertainty as to whether, following a UK exit from the EUU.K. financial institutions or the EEA (whateverfailure to put equally effective arrangements in place). This may increase costs or make it more difficult for us to pursue our objectives. As a new agreement, the form thereof), a passporting regime (or similar regime in its effect) will apply (if at all). Depending onimplications and the termsoperation of the UK’s exit and the terms of any replacement relationship, it is likely that UK regulated entities may, on the UK’s withdrawal from the EU, lose the right to passport their services to EEA countries, and EEA entities may lose the right to reciprocal passporting into the UK. The movement of capital and the mobility of personnelTCA may also be restricted. Also, UK entities may no longer have access rightssubject to market infrastructure across the EU and the recognition of insolvency, bank recovery and resolution regimes across the EU may no longer be mutual. change and/or develop at short notice.
These complex issues and other by-products of Brexit, such as the tightening of credit in the UKU.K. commercial real estate market, may also increase the costs of having operations, conducting business and making investments in the UKU.K. and Europe. As a result, the performance of our funds which are focused on investing in the UKU.K. and to a lesser extent across Europe, such as certain funds in our Credit and Real Estate Groups may be disproportionately affected compared to those funds that invest more broadly across global geographies or are focused on different regions.
The Brexit vote could causeuncertainty surrounding the precise nature of the U.K.’s future legal relationship with the EU may continue to be a source of significant exchange rate fluctuations that result inand/or other adverse effects on international markets. Unhedged currency fluctuations have the strengthening of the U.S. dollar against foreign currencies in which we conduct business, including the British pound and the Euro. Where un-hedged, the strengthening of the U.S. dollar relativeability to other currencies may, among other things, adversely affect the results of operations of our funds and their underlying business investments, that are denominated in non-U.S. dollar currencies and also adversely affect businesses that rely onas well as the strengthrelative value of foreign currencies against the U.S. dollar, and thereby have a negative impact on our investments in those businesses. Movements in the rate of exchange between the U.S. dollar and non-U.S. dollar currencies affect the management fees earned by funds with fee earning AUM denominated in non-U.S. dollar currencies as well as by funds with fee earning AUM denominated in U.S. dollars that hold investments denominated in non-U.S. dollar currencies. Additionally, movements in exchange rates affect operatingand impact of operational expenses for our foreign offices that are denominated in non-U.S. currencies, cash balances we hold in non-U.S. currencies and investments we hold in non-U.S. currencies.on profitability.
Further, the UK’s determination asdevelopment of the U.K.’s future legislative approach remains uncertain. The U.K. may elect in the future to which, if any,repeal, amend or replace EU laws, to repeal, retain, replace or replicate upon its exit from the EUwhich could exacerbate the uncertainty and result in divergent U.K. national laws and regulations. Changes to the regulatory regimes in the UKU.K. or the EU and its member states could materially affect our business prospects and opportunities and increase our costs. In addition, Brexit could potentially disrupt the tax jurisdictions in which we operate and affect the tax benefits or liabilities in these or other jurisdictions in a manner that is adverse to us and/or our funds. Post-Brexit regulations could potentially impact the ability of regulated entities operating, providing services and marketing on a cross-border basis in other EEA countries in reliance on passporting rights and without the need for a separate license or authorization which may impact our ability to raise new funds. Any of the foregoing could materially and adversely affect our business, results of operations and financial condition.
We are subject to risks in using prime brokers, custodians, counterparties, administrators and other agents.
Many of our funds depend on the services of prime brokers, custodians, counterparties, administrators and other agents to carry out certain securities and derivatives transactions.transactions and other administrative services. We are subject to risks of errors and mistakes made by these third parties, which may be attributed to us and subject us or our fund investors to reputational damage, penalties or losses. We may be unsuccessful in seeking reimbursement or indemnification from these third-party service providers.
The terms of the contracts with these contractsthird-party service providers are often customized and complex, and many of these arrangements occur in markets or relate to products that are not subject to regulatory oversight, although the Dodd-Frank Act provides for new regulation of the derivatives market. In particular, some of our funds utilize prime brokerage arrangements with a relatively limited number of counterparties, which has the effect of concentrating the transaction volume (and related counterparty default risk) of these funds with these counterparties.
Our funds are subject to the risk that the counterparty to one or more of these contracts defaults, either voluntarily or involuntarily, on its performance under the contract. Any such default may occur suddenly and without notice to us. Moreover, if a counterparty defaults, we may be unable to take action to cover our exposure, either because we lack contractual recourse or because market conditions make it difficult to take effective action. This inability could occur in times of market stress, which is when defaults are most likely to occur.
In addition, our risk-management models may not accurately anticipate the impact of market stress or counterparty financial condition, and as a result, we may not have taken sufficient action to reduce our risks effectively. Default risk may arise from events or circumstances that are difficult to detect, foresee or evaluate. In addition, concerns about, or a default by, one large participant could lead to significant liquidity problems for other participants, which may in turn expose us to significant losses.
Although we have risk-management models and processes to ensure that we are not exposed to a single counterparty for significant periods of time, given the large number and size of our funds, we often have large positions with a single counterparty. For example, most of our funds have credit lines. If the lender under one or more of those credit lines were to become insolvent, we may have difficulty replacing the credit line and one or more of our funds may face liquidity problems.
In the event of a counterparty default, particularly a default by a major investment bank or a default by a counterparty to a significant number of our contracts, one or more of our funds may have outstanding trades that they cannot settle or are
delayed in settling. As a result, these funds could incur material losses and the resulting market impact of a major counterparty default could harm our businesses, results of operation and financial condition.
In the event of the insolvency of a prime broker, custodian, counterparty or any other party that is holding assets of our funds as collateral, our funds might not be able to recover equivalent assets in full as they will rank among the prime broker’s, custodian’s or counterparty’s unsecured creditors in relation to the assets held as collateral. In addition, our funds’ cash held with a prime broker, custodian or counterparty generally will not be segregated from the prime broker’s, custodian’s or counterparty’s own cash, and our funds may therefore rank as unsecured creditors in relation thereto. If our derivatives transactions are cleared through a derivatives clearing organization, the CFTC has issued final rules regulating the segregation and protection of collateral posted by customers of cleared and uncleared swaps. The CFTC is also working to provide new guidance regarding prime broker arrangements and intermediation generally with regard to trading on swap execution facilities.
The counterparty risks that we face have increased in complexity and magnitude as a result of disruption in the financial markets in recent years. For example, the consolidation and elimination of counterparties has increased our concentration of counterparty risk and decreased the universe of potential counterparties, and our funds are generally not restricted from dealing with any particular counterparty or from concentrating any or all of their transactions with one counterparty. In addition, counterparties have generally reacted to recent market volatility by tightening their underwriting standards and increasing their margin requirements for all categories of financing, which has the result of decreasing the overall amount of leverage available and increasing the costs of borrowing.
A portion of our revenue, net incomeearnings and cash flow is variable, which may make it difficult for us to achieve steady earnings growth on a quarterly basis and may cause the price of shares of our Class A common sharesstock to decline.
A portion of our revenue, net incomeearnings and cash flow is variable, primarily due to the fact that the performance feesincome that we receive from certain of our funds can vary from quarter to quarter and year to year. In addition, the investment returns of most of our funds are volatile. We may also experience fluctuations in our results from quarter to quarter and year to year due to a number of other factors, including changes in the values of our funds’ investments, changes in the amount of distributions, dividends or interest paid in respect of investments, changes in our operating expenses, the degree to which we encounter competition and general economic and market conditions. Such variability may lead to volatility in the trading price of shares of our Class A common sharesstock and cause our results for a particular period not to be indicative of our performance in a future period. It may be difficult for us to achieve steady growth in net incomeearnings and cash flow on a quarterly basis, which could in turn lead to large adverse movements in the price of shares of our Class A common sharesstock or increased volatility in the price of shares of our Class A common sharesstock generally.
The timing and amount of performance feesincome generated by our funds is uncertain and contributes to the volatility of our results. It takes a substantial period of time to identify attractive investment opportunities, to raise all the funds needed to makediligence and finance an investment and then to realize the cash value or other proceeds of an investment through a sale, public offering, recapitalization or other exit. Even if an investment proves to be profitable, it may be several years before any profits can be realized in cash or other proceeds. We cannot predict when, or if, any realization of investments will occur. If we were to have a realization event in a particular quarter or year, it may have a significant impact on our results for that particular quarter or year that may not be replicated in subsequent periods. We recognize revenue on investments in our funds based on our allocable share of realized and unrealized gains (or losses) reported by such funds, and a decline in realized or unrealized gains, or an increase in realized or unrealized losses, would adversely affect our revenue, which could increase the volatility of our results.
With respect to our funds that generate carried interest, the timing and receipt of such carried interest varies with the life cycle of our funds. During periods in which a relatively large portion of our assets under management is attributable to funds and investments in their “harvesting” period, our funds would make larger distributions than in the fund-raising or investment periods that precede harvesting. During periods in which a significant portion of our assets under management is attributable to funds that are not in their harvesting periods, we may receive substantially lower carried interest distributions. Moreover in some cases, we receive carried interest payments only upon realization of investments by the relevant fund, which contributes to the volatility of our cash flow and in other funds we are only entitled to carried interest payments after a return of all contributions and a preferred return to investors.
With respect to our funds that pay an incentive fee, the incentive fee is generally paid annually. In many cases, we earn this incentive fee only if the net asset value of a fund has increased or, in the case of certain funds, increased beyond a particular threshold. Some of our funds also have “high water marks”. If the high water mark for a particular fund is not surpassed, we would not earn an incentive fee with respect to that fund during a particular period even if the fund had positive returns in such period as a result of losses in prior periods. If the fund were to experience losses, we would not be able to earn an incentive fee from such fund until it surpassed the previous high water mark. The incentive fees we earn are, therefore, dependent on the net asset value of our fund investments, which could lead to significant volatility in our results. Finally, the timing and amount of incentive fees generated by our closed-end funds are uncertain and will contribute to the volatility of our net income.earnings. Incentive fees depend on our closed-end funds’ investment performance and opportunities for realizing gains, which may be limited.
Because a portion of our revenue, net incomeearnings and cash flow can be variable from quarter to quarter and year to year, we do not plan to provide any guidance regarding our expected quarterly and annual operating results. The lack of guidance may affect the expectations of public market analysts and could cause increased volatility in the price of our common shares.
Cybersecurity risks and cyber incidents could adversely affect our business by causing a disruption to our operations, a compromise or corruptionshares of our confidential information and/or damage to our business relationships, any of which could negatively impact our business, financial condition and operating results.
There has been an increase in the frequency and sophistication of the cyber and security threats we face, with attacks ranging from thoseClass A common to businesses generally to those that are more advanced and persistent, which may target us because, as an alternative asset management firm, we hold confidential and other price sensitive information about existing and potential investments. As a result, we may face a heightened risk of a security breach or disruption with respect to sensitive information resulting from an attack by computer hackers, foreign governments or cyber terrorists.
The efficient operation of our business is dependent on computer hardware and software systems, as well as data processing systems and the secure processing, storage and transmission of information, which are vulnerable to security breaches and cyber incidents. A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. In addition, we and our employees may be the target of fraudulent emails or other targeted attempts to gain unauthorized access to proprietary or sensitive information. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our business relationships, causing our business and results of operations to suffer. As our reliance on technology has increased, so have the risks posed to our information systems, both internal and those provided by third-party service providers. We have implemented processes, procedures and internal controls designed to mitigate cybersecurity risks and cyber intrusions and rely on industry accepted securities measures and technology to securely maintain confidential and proprietary information maintained on our information systems; however, these measures, as well as our increased awareness of the nature and extent of a risk of a cyber-incident, do not guarantee that a cyber-incident will not occur and/or that our financial results, operations or confidential information will not be negatively impacted by such an incident.
These risks are exacerbated by the rapidly increasing volume of highly sensitive data, including our proprietary business information and intellectual property, and personally identifiable information of our employees and our investors, that we collect and store in our data centers and on our networks. The secure processing, maintenance and transmission of this information are critical to our operations. A significant actual or potential theft, loss, corruption, exposure, fraudulent use or misuse of investor, employee or other personally identifiable or proprietary business data, whether by third parties or as a result of employee malfeasance or otherwise, non-compliance with our contractual or other legal obligations regarding such data or intellectual property or a violation of our privacy and security policies with respect to such data could result in significant remediation and other costs, fines, litigation or regulatory actions against us and significant reputational harm.
Our funds’ portfolio companies also rely on similar systems and face similar risks. A disruption or compromise of these systems could have a material adverse effect on the value of these businesses. Our funds may invest in strategic assets having a national or regional profile or in infrastructure assets, the nature of which could expose them to a greater risk of being subject to a terrorist attack or security breach than other assets or businesses.
Cybersecurity has become a priority for regulators in the U.S. and around the world. For example, the SEC has announced that one of the 2018 examination priorities for the Office of Compliance Inspections and Examinations is on cybersecurity procedures and controls. In addition, the new European General Data Protection Regulation (“GDPR”) will come into effect in May 2018. Data protection requirements under the GDPR will be more stringent than those imposed under existing European legislation. Additional restrictions on our ability to use and retain personal data could impede our business while the financial penalties for non-compliance could be up to the higher of 20 million Euros or 4% of group annual turnover.
We expect to be required to devote increasing levels of funding and resources to comply with evolving cybersecurity regulations and to continually monitor and enhance our cybersecurity procedures and controls.
We may be subject to litigation risks and may face liabilities and damage to our professional reputation as a result.
In recent years, the volume of claims and amount of damages claimed in litigation and regulatory proceedings against investment managers have been increasing. We make investment decisions on behalf of investors in our funds that could result in substantial losses. This may subject us to the risk of legal liabilities or actions alleging negligent misconduct, breach of fiduciary duty or breach of contract. Further, we may be subject to third-party litigation arising from allegations that we improperly exercised control or influence over portfolio investments. In addition, we and our affiliates that are the investment managers and general partners of our funds, our funds themselves and those of our employees who are our, our subsidiaries’ or the funds’ officers and directors are each exposed to the risks of litigation specific to the funds’ investment activities and portfolio companies and, in the case where our funds own controlling interests in public companies, to the risk of shareholder litigation by the public companies’ other shareholders. Moreover, we are exposed to risks of litigation or investigation by investors or regulators relating to our having engaged, or our funds having engaged, in transactions that presented conflicts of interest that were not properly addressed.
Legal liability could have a material adverse effect on our businesses, financial condition or results of operations or cause reputational harm to us, which could harm our businesses. We depend to a large extent on our business relationships and our reputation for integrity and high-caliber professional services to attract and retain investors and to pursue investment opportunities for our funds. As a result, allegations of improper conduct by private litigants or regulators, whether the ultimate outcome is favorable or unfavorable to us, as well as negative publicity and press speculation about us, our investment activities or the investment industry in general, whether or not valid, may harm our reputation, which may be damaging to our businesses.
In addition, the laws and regulations governing the limited liability of such issuers and portfolio companies vary from jurisdiction to jurisdiction, and in certain contexts the laws of certain jurisdictions may provide not only for carve-outs from limited liability protection for the issuer or portfolio company that has incurred the liabilities, but also for recourse to assets of other entities under common control with, or that are part of the same economic group as, such issuer. For example, if one of our portfolio companies is subject to bankruptcy or insolvency proceedings in a jurisdiction and is found to have liabilities under the local consumer protection, labor, tax or bankruptcy laws, the laws of that jurisdiction may permit authorities or creditors to file a lien on, or to otherwise have recourse to, assets held by other portfolio companies (including assets held by us) in that jurisdiction. There can be no assurance that we will not be adversely affected as a result of the foregoing risks.stock.
Employee misconduct could harm us by impairing our ability to attract and retain investors and subjecting us to significant legal liability, regulatory scrutiny and reputational harm.
Our ability to attract and retain investors and to pursue investment opportunities for our funds depends heavily upon the reputation of our professionals, especially our senior professionals. We are subject to a number of obligations and standards arising from our investment management business and our authority over the assets managed by our investment management business.
Further, our employees are subject to various internal policies including a Code of Ethics and policies covering information systems, business continuity and information security. The violation of these obligations, standards and policies by any of our employees could adversely affect investors in our funds and us. Our businesses often require that we deal with confidential matters of great significance to companies in which our funds may invest. If our employees or former employees were to use or disclose confidential information improperly, we could suffer serious harm to our reputation, financial position and current and future business relationships. Employee misconduct could also include, among other things, binding us to transactions that exceed authorized limits or present unacceptable risks and other unauthorized activities or concealing unsuccessful investments (which, in either case, may result in unknown and unmanaged risks or losses), concealing or failing to disclose conflicts of interest with our funds or portfolio companies or otherwise charging (or seeking to charge) inappropriate expenses.expenses or inappropriate or unlawful behavior or actions directed towards other employees.
It is not always possible to detect or deter employee misconduct, and the extensive precautions we take to detect and prevent this activity may not be effective in all cases. If one or more of our employees or former employees were to engage in misconduct or were to be accused of such misconduct, our businesses and our reputation could be adversely affected and a loss of investor confidence could result, which would adversely impact our ability to raise future funds. Our current and former employees and those of our portfolio companies may also become subject to allegations of sexual harassment, racial and gender discrimination or other similar misconduct, which, regardless of the ultimate outcome, may result in adverse publicity that could harm our and such portfolio company’s brand and reputation.
Fraud and other deceptive practices or other misconduct at our portfolio companies, properties or projects could similarly subject us to liability and reputational damage and also harm our businesses.
In recent years, the U.S. Department of Justice and the SEC have devoted greater resources to enforcement of the FCPA. In addition, the United KingdomU.K. significantly expanded the reach of its anti-bribery law with the creation of the U.K. Bribery Act of 2010 (the “UK“U.K. Bribery Act”). The UKU.K. Bribery Act prohibits companies that conduct business in the United KingdomU.K. and their employees and representatives from giving, offering or promising bribes to any person, including non-UKnon-U.K. government officials, as well as requesting, agreeing to receive or accepting bribes from any person. Under the UKU.K. Bribery Act, companies may be held liable for failing to prevent their employees and associated persons from violating the UK Bribery Act. While we have developed and implemented policies and procedures designed to ensure strict compliance by us and our personnel with the FCPA and UKU.K. Bribery Act, such policies and procedures may not be effective in all instances to prevent violations. Any determination that we have violated the FCPA, the UKU.K. Bribery Act or other applicable anti-corruption laws could subject us to, among other things, civil and criminal penalties, material fines, profit disgorgement, injunctions on future conduct, securities litigation and a general loss of investor confidence, any one of which could adversely affect our business prospects, financial position or the market value of shares of our Class A common shares.stock.
In addition, we could be adversely affected as a result of actual or alleged misconduct by personnel of portfolio companies, properties or projects in which our funds invest. For example, failures by personnel at our portfolio companies, properties or projects to comply with anti-bribery, trade sanctions, Federal Energy Regulatory Commission or Environmental Protection Agency regulations or other legal and regulatory requirements could expose us to litigation or regulatory action and otherwise adversely affect our businesses and reputation. Such misconduct could negatively affect the valuation of a fund’s investments and consequently affect our funds’ performance and negatively impact our businesses. In addition, we may face an increased risk of such misconduct to the extent our investment in non-U.S. markets, particularly emerging markets, increase. Such markets may not have established laws and regulations that are as stringent as in more developed nations, or existing laws and regulations may not be consistently enforced. For example, we may invest throughout jurisdictions that have material perceptions of corruption according to international rating standards (such as Transparency International’s Corruption Perceptions Index) such as China and India. Due diligence on investment opportunities in these jurisdictions is frequently more complicated because consistent and uniform commercial practices in such locations may not have developed. Misconduct may be especially difficult to detect in such locations, and compliance with applicable laws may be difficult to maintain and monitor.
Our use of leverage to finance our businesses exposes us to substantial risks.
As of December 31, 2017,2020, we had $210.0 million ofno borrowings outstanding under our credit facility (the “Credit Facility”) and $406.2$650.0 million aggregate principal amount of senior notes outstanding. We may choose to finance our businesses operations through further borrowings under the Credit Facility or by issuing additional debt. Our existing and future indebtedness exposes us to the typical risks associated with the use of leverage, including the same risks that are applicable to our funds that use leverage as discussed below under “-Risks Related to Our Funds-Dependence on significant leverage in investments by our funds subjects us to volatility and contractions in the debt financing markets and could adversely affect our ability to achieve attractive rates of return on those investments.” The occurrence or continuation of any of these events or trends could cause us to suffer a decline in the credit ratings assigned to our debt by rating agencies, which would cause the interest rate applicable to borrowings under the Credit Facility to increase and could result in other material adverse effects on our businesses. We depend on financial institutions extending credit to us on terms that are reasonable to us. There is no guarantee that such institutions will continue to extend credit to us or renew any existing credit agreements we may have with them, or that we will be able to refinance outstanding facilities when they mature. [InIn addition, the incurrence of additional debt in the future could result in potential downgrades of our existing corporate credit ratings, which could limit the availability of future financing and/or increase our cost of borrowing.] Furthermore, our Credit Facility and the indenture governing our senior notes contain certain covenants with which we need to comply. Non-compliance with any of the covenants without cure or waiver would constitute an event of default, and an event of default resulting from a breach of certain covenants could result, at the option of the lenders, in an acceleration of the principal and interest outstanding. In addition, if we incur additional debt, our credit rating could be adversely impacted.
Borrowings under the Credit Facility will mature in February 2022March 2025 and theour tranches of senior notes mature in October 2024.2024 and June 2030, respectively. As these borrowings and other indebtedness mature (or are otherwise repaid prior to their scheduled maturities), we may be required to
either refinance them by entering into new facilities or issuing additional debt, which could result in higher borrowing costs, or issuing equity, which would dilute existing shareholders.stockholders. We could also repay these borrowings by using cash on hand, cash provided by our continuing operations or cash from the sale of our assets, which could reduce distributions to holders of our Class A common shareholders.stock. We may be unable to enter into new facilities or issue debt or equity in the future on attractive terms, or at all. Borrowings under the Credit Facility are LIBOR-based obligations. As a result, an increase in short-term interest rates will increase our interest costs if such borrowings have not been hedged into fixed rates.
The risks related to our use of leverage may be exacerbated by our funds’ use of leverage to finance investments. See “-Risks Related to Our Funds-Dependence on significant leverage in investments by our funds subjects us to volatility and contractions in the debt financing markets and could adversely affect our ability to achieve attractive rates of returns on those investments.”
We are exposed to risks associated with changes in interest rates.
General interest rate fluctuations may have a substantial negative impact on our investments and investment opportunities and, accordingly, may have a material adverse effect on our investment objective and our net investment income. Because we borrow money and may issue debt securities or preferred stock to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds or pay interest or dividends on such debt securities or preferred stock and the rate at which we invest these funds. If market rates decrease we may earn less interest income from investments made during such lower rate environment. From time to time, we may also enter into certain hedging transactions to mitigate our exposure to changes in interest rates. In the past, we have entered into certain hedging transactions, such as interest rate swap agreements, to mitigate our exposure to adverse fluctuations in interest rates, and we may do so again in the future. In addition, we may increase our floating rate investments to position the portfolio for rate increases. However, we cannot assure you that such transactions will be successful in mitigating our exposure to interest rate risk. There can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income.
Trading prices tend to fluctuate more for fixed-rate securities that have longer maturities. Although we have no policy governing the maturities of our investments, under current market conditions we expect that we will invest in a portfolio of debt generally having maturities of up to 10 years. Trading prices for debt that pays a fixed rate of return tend to fall as interest rates rise. This means that we are subject to greater risk (other things being equal) than a fund invested solely in shorter-term securities. A decline in the prices of the debt we own could adversely affect the trading price of our common stock. Also, an increase in interest rates available to investors could make an investment in our common stock less attractive if we are not able to increase our dividend rate, which could reduce the value of our common stock.
Operational risks may disrupt our businesses, result in losses or limit our growth.
We face operational risk from errors made in the execution, confirmation or settlement of transactions. We also face operational risk from transactions and key data not being properly recorded, evaluated or accounted for in our funds. In particular, our Credit Group, and to a lesser extent our Private Equity Group, are highly dependent on our ability to process and evaluate, on a daily basis, transactions across markets and geographies in a time-sensitive, efficient and accurate manner. Consequently, we rely heavily on our financial, accounting and other data processing systems. New investment products we may introduce could create a significant risk that our existing systems may not be adequate to identify or control the relevant risks in the investment strategies employed by such new investment products.
In addition, we operate in a business that is highly dependent on information systems and technology. Our information systems and technology may not continue to be able to accommodate our growth, particularly our growth internationally, and the cost of maintaining the systems may increase from its current level. Such a failure to accommodate growth, or an increase in costs related to the information systems, could have a material adverse effect on our business and results of operations.
Furthermore, our headquarters and a substantial portion of our personnel are located in Los Angeles. An earthquake or other disaster or a disruption in the infrastructure that supports our businesses, including a disruption involving electronic communications, our internal human resources systems or other services used by us or third parties with whom we conduct business, or directly affecting our headquarters, could have a material adverse effect on our ability to continue to operate our businesses without interruption. Although we have disaster recovery programs in place, these may not be sufficient to mitigate the harm that may result from such a disaster or disruption. In addition, insurance and other safeguards might only partially reimburse us for our losses, if at all.
Finally, we rely on third-party service providers for certain aspects of our businesses, including for certain information systems, technology and administration of our funds and compliance matters. Operational risks could increase as vendors increasingly offer mobile and cloud-based software services rather than software services that can be operated within our own data centers, as certain aspects of the security of such technologies may be complex, unpredictable or beyond our control, and any failure by mobile technology and cloud service providers to adequately safeguard their systems and prevent cyber-attacks, could disrupt our operations and result in misappropriation, corruption or loss of confidential or proprietary information. In addition, our counterparties’ information systems, technology and accounts may be the target of cyber attacks and identity theft. Any interruption or deterioration in the performance of these third parties or the service providers of our counterparties or failures of their respective information systems and technology could impair the quality of our funds’ operations and could impact our reputation, adversely affect our businesses and limit our ability to grow.
We have made a significant investment in a subsidiary that is the sponsor of a SPAC, and will suffer the loss of all of our investment if the SPAC does not complete an acquisition within two years.
In February 2021, we invested $23.0 million into a subsidiary that is the sponsor of Ares Acquisition Corp (NYSE: AAC), a blank check company. Prior to a business combination, the Sponsor (and its permitted transferees) holds 100% of the Class B ordinary shares outstanding of AAC. The Class B ordinary shares equal 20% of the outstanding Class A ordinary shares of AAC. Upon the successful completion of an acquisition the pro forma ownership of the new company will vary depending on the business combination terms. There can be no assurances that this scenario and the resulting ownership will manifest, as changes may be made depending upon business combination terms. There is no assurance that the SPAC will be successful in completing a business combination or that any business combination will be successful. The Company can lose its entire investment in the SPAC if a business combination is not completed within 24 months or if the business combination is not successful, which may adversely impact our stockholder value.
Risks Related to Our Funds
The historical returns attributable to our funds should not be considered as indicative of the future results of our funds or of our future results or of any returns expected on an investment in shares of our Class A common shares.stock.
The historical performance of our funds is relevant to us primarily insofar as it is indicative of performance feesincome we have earned in the past and may earn in the future and our reputation and ability to raise new funds and therefore earn management fees on such new funds. The historical and potential returns of the funds we advise are not, however, directly linked to returns on shares of our Class A common shares.stock. Therefore, holders of our Class A common sharesstock should not conclude that positive performance of the funds we advise will necessarily result in positive returns on an investment in shares of our Class A common shares. However, poor performance of the funds we advise would likely cause a decline in our revenues and would therefore likely have a negative effect on our operating results and returns on our common shares.stock. An investment in shares of our sharesClass A common stock is not an investment in any of our funds. Also, there is no assurance that projections in respect of our funds or unrealized valuations will be realized.
Moreover, the historical returns of our funds should not be considered indicative of the future returns of these or from any future funds we may raise, in part because:
•market conditions during previous periods may have been significantly more favorable for generating positive performance than the market conditions we may experience in the future;
•our funds’ rates of returns, which are calculated on the basis of net asset value of the funds’ investments, reflect unrealized gains, which may never be realized;
•our funds’ returns have previously benefited from investment opportunities and general market conditions that may not recur, including the availability of debt capital on attractive terms and the availability of distressed debt opportunities, and we may not be able to achieve the same returns or profitable investment opportunities or deploy capital as quickly;
•the historical returns that we present in this Annual Report on Form 10-K derive largely from the performance of our earlier funds, whereas future fund returns will depend increasingly on the performance of our newer funds or funds not yet formed, which may have little or no realized investment track record;
•our funds’ historical investments were made over a long period of time and over the course of various market and macroeconomic cycles, and the circumstances under which our current or future funds may make future investments may differ significantly from those conditions prevailing in the past;
•the attractive returns of certain of our funds have been driven by the rapid return of invested capital, which has not occurred with respect to all of our funds and we believe is less likely to occur in the future;
•in recent years, there has been increased competition for private equity investment opportunities resulting from the increased amount of capital invested in alternative funds and high liquidity in debt markets, and the increased competition for investments may reduce our returns in the future; and
•our newly established funds may generate lower returns during the period that they take to deploy their capital.
The future internal rate of return for any current or future fund may vary considerably from the historical internal rate of return generated by any particular fund, or for our funds as a whole. Future returns will also be affected by the risks described elsewhere in this Annual Report on Form 10-K, including risks of the industries and businesses in which a particular fund invests.
Valuation methodologies for certain assets can be subject to significant subjectivity, and the values of assets may never be realized.
Many of the investments inof our funds are illiquid and thus have no readily ascertainable market prices. We value these investments based on our estimate, or an independent third party’s estimate, of their fair value as of the date of determination, which often involves significant subjectivity. There is no single standard for determining fair value in good faith and in many cases fair value is best expressed as a range of fair values from which a single estimate may be derived. We estimate the fair value of our investments based on third-party models, or models developed by us, which include discounted cash flow analyses and other techniques and may be based, at least in part, on independently sourced market parameters. The material estimates and assumptions used in these models include the timing and expected amount of cash flows, the appropriateness of discount rates used, and, in some cases, the ability to execute, the timing of and the estimated proceeds from expected financings, some or all of which factors may be ascribed more or less weight in light of the particular circumstances. The actual results related to any particular investment often vary materially as a result of the inaccuracy of these estimates and assumptions. In addition, because many of the illiquid investments held by our funds are in industries or sectors which are unstable, in distress or undergoing some uncertainty, such investments are subject to rapid changes in value caused by sudden company-specific or industry-wide developments.
We include the fair value of illiquid assets in the calculations of net asset values, returns of our funds and our assets under management. Furthermore, we recognize performance feesincome from affiliates based in part on these estimated fair values. Because these valuations are inherently uncertain, they may fluctuate greatly from period to period. Also, they may vary greatly from the prices that would be obtained if the assets were to be liquidated on the date of the valuation and often do vary greatly from the prices we eventually realize; as a result, there can be no assurance that such unrealized valuations will be fully or timely realized.
In addition, the values of our investments in publicly traded assets are subject to significant volatility, including due to a number of factors beyond our control. These include actual or anticipated fluctuations in the quarterly and annual results of
these companies or other companies in their industries, market perceptions concerning the availability of additional securities for sale, general economic, social or political developments, changes in industry conditions or government regulations, changes in management or capital structure and significant acquisitions and dispositions. Because the market prices of these securities can be volatile, the valuations of these assets change from period to period, and the valuation for any particular period may not be realized at the time of disposition. In addition, market values may be based on indicative rather than actual trading prices, and may therefore lack precision. Further, because our funds often hold large positions in their portfolio companies, the disposition of these securities often is delayed for, or takes place over, long periods of time, which can further expose us to volatility risk. Even if we hold a quantity of public securities that may be difficult to sell in a single transaction, we do not discount the market price of the security for purposes of our valuations.
Although we frequently engage independent third parties to perform the foregoing valuations, the valuation process remains inherently subjective for the reasons described above.
If we realize value on an investment that is significantly lower than the value at which it was reflected in a fund’s net asset values, we would suffer losses in the applicable fund. This could in turn lead to a decline in asset management fees and a loss equal to the portion of the performance feesincome from affiliates reported in prior periods that was not realized upon disposition. These effects could become applicable to a large number of our investments if our estimates and assumptions used in estimating their fair values differ from future valuations due to market developments. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Segment Analysis” for information related to fund activity that is no longer consolidated. If asset values turn out to be materially different than values reflected in fund net asset values, fund investors could lose confidence which could, in turn, result in difficulties in raising additional investments.
Market values of debt instruments and publicly traded securities that our funds hold as investments may be volatile.
The market prices of debt instruments and publicly traded securities held by some of our funds may be volatile and are likely to fluctuate due to a number of factors beyond our control, including actual or anticipated changes in the profitability of the issuers of such securities, general economic, social or political developments, changes in industry conditions, changes in government regulation, shortfalls in operating results from levels forecast by securities analysts, inflation and rapid fluctuations in inflation rates and the general state of the securities markets as described above under “Risks Related to Our Business-Difficult market and political conditions may adversely affect our businesses in many ways, including by reducing the value or hampering the performance of the investments made by our funds or reducing the ability of our funds to raise or deploy capital, each of which could materially reduce our revenue, net incomeearnings and cash flow and adversely affect our financial prospects and condition,” and other material events, such as significant management changes, financings, re-financings, securities issuances, acquisitions and dispositions. The value of publicly traded securities in which our funds invest may be particularly volatile as a result of these factors. In addition, debt instruments that are held by our funds to maturity or for long terms must be “marked-to-market” periodically, and their values are therefore vulnerable to interest rate fluctuations and the changes in the general state of the credit environment, notwithstanding their underlying performance. Changes in the values of these investments may adversely affect our investment performance and our results of operations.
Our funds may be unable to deploy capital at a steady and consistent pace, which could have an adverse effect on our results of operations and future fundraising.
The pace and consistency of our funds’ capital deployment has been, and may in the future continue to be, affected by a range of factors, including market conditions, regulatory developments and increased competition, which are beyond our control. During the same period, our AUM not yet paying fees increased due to ongoing fundraising. While this AUM not yet paying fees represents significant future fee-earning potential, our inability to deploy this capital on the timeframe we expect, or at all, and on terms that we believe are attractive, would reduce or delay the management and performance income that we would otherwise expect to earn on this capital. Any such reduction or delay would impair our ability to offset investments in additional resources that we often make to manage new capital, including hiring additional professionals. Moreover, we could be delayed in raising successor funds. The impact of any such reduction or delay would be particularly adverse with respect to funds where management fees are paid on invested capital. Any of the foregoing could have a material adverse effect on our results of operations and growth.
Our funds depend on investment cycles, and any change in such cycles could have an adverse effect on our investment prospects.
Cyclicality is important to our businesses. Weak economic environments have often provided attractive investment opportunities and strong relative investment performance. For example, the relative performance of our high yield bond strategy has typically been strongest in difficult times when default rates are highest, and our distressed debt and control investing funds have historically identified investment opportunities during downturns in the economy when credit is not as readily available. Conversely, we tend to realize value from our investments in times of economic expansion, when opportunities to sell investments may be greater. Thus, we depend on the cyclicality of the market to sustain our businesses and generate attractive risk-adjusted returns over extended periods. Any significant ongoing volatility or
prolonged economic expansion or recession could have an adverse impact on certain of our funds and materially affect our ability to deliver attractive investment returns or generate incentive or other income.
Dependence on significant leverage in investments by our funds subjects us to volatility and contractions in the debt financing markets and could adversely affect our ability to achieve attractive rates of return on those investments.
Some of our funds and their investments rely on the use of leverage, and our ability to achieve attractive rates of return on investments will depend on our ability to access sufficient sources of indebtedness at attractive rates. If our funds or the companies in which our funds invest raise capital in the structured credit, leveraged loan, and high yield bond or investment grade bond markets, the results
of their operations may suffer if such markets experience dislocations, contractions or volatility. Any such events could adversely impact the availability of credit to businesses generally and could lead to an overall weakening of the U.S. and global economies.
Recently, the credit markets have experienced heightened volatility. Interest rates have increased, and the Federal Reserve has raised the federal funds rate on multiple occasions since 2015, with ongoing increases expected. Further, many other economies are experiencing weakness, with tighter credit conditions and a decreased availability of foreign capital. These developments have caused borrowing costs to rise and decreased the availability of leverage and the attractiveness of the terms on which we, our funds and our portfolio companies were able to obtain debt financing. Furthermore, some of the provisions under the Tax Cuts and Jobs Act could have a negative impact on the cost of financing and dampen the attractiveness of credit. Significant ongoing volatility or a protracted economic downturn could adversely affect the financial resources of our funds and their investments (in particular those investments that depend on credit from third parties or that otherwise participate in the credit markets) and their ability to make principal and interest payments on outstanding debt, or refinance outstanding debt when due. Moreover, these events could affect the terms of available debt financing with, for example, higher rates, higher equity requirements and/or more restrictive covenants, particularly in the area of acquisition financings for leveraged buyout and real estate assets transactions.
The absence of available sources of sufficient debt financing for extended periods of time or an increase in either the general levels of interest rates or in the risk spread demanded by sources of indebtedness would make it more expensive to finance those investments. Future increases in interest rates could also make it more difficult to locate and consummate investments because other potential buyers, including operating companies acting as strategic buyers, may be able to bid for an asset at a higher price due to a lower overall cost of capital or their ability to benefit from a higher amount of cost savings following the acquisition of the asset. In addition, a portion of the indebtedness used to finance investments often includes high yield debt securities issued in the capital markets. Availability of capital from the high yield debt markets is subject to significant volatility, and there may be times when weour funds are unable to access those markets at attractive rates, or at all, when completing an investment. Certain investments may also be financed through borrowings on fund-level debt facilities, which may or may not be available for a refinancing at the end of their respective terms. Finally, the interest payments on the indebtedness used to finance our funds’ investments are generally deductible expenses for income tax purposes under current law, subject to limitations under applicable tax law and policy. The Tax Cuts and Jobs Act imposes additional limitations on the deductibility of net business interest expenses, and any future change in tax law or policy could reduce the after-tax rates of return on the affected investments, which may have an adverse impact on our businesses and financial results. See “-Our funds make investments in companies that are based outside of the United States, which may expose us to additional risks not typically associated with investing in companies that are based in the United States.”
In the event that our funds are unable to obtain committed debt financing for potential acquisitions or can only obtain debt at an increased interest rate or on unfavorable terms, our funds may have difficulty completing otherwise profitable acquisitions or may generate profits that are lower than would otherwise be the case, either of which could reduce the performance and investment income earned by us. Similarly, our funds’ portfolio companies regularly utilize the corporate debt markets to obtain financing for their operations. If the credit markets continue to render such financing difficult to obtain or more expensive, this may negatively impact the operating performance of those portfolio companies and, therefore, the investment returns of our funds. In addition, if the markets make it difficult or impossible to refinance debt that is maturing in the near term, some of our portfolio companies may be unable to repay such debt at maturity and may be forced to sell assets, undergo a recapitalization or seek bankruptcy protection. Any of the foregoing circumstances could have a material adverse effect on our financial condition, results of operations and cash flow.
When our funds’ existing portfolio investments reach the point when debt incurred to finance those investments matures in significant amounts and must be either repaid or refinanced, those investments may materially suffer if they have not generated sufficient cash flow to repay maturing debt and there is insufficient capacity and availability in the financing markets to permit them to refinance maturing debt on satisfactory terms, or at all. A persistence of the limited availability of financing for such purposes for an extended period of time when significant amounts of the debt incurred to finance our funds’ existing portfolio investments becomes due could have a material adverse effect on these funds.
Our funds may choose to use leverage as part of their respective investment programs and certain funds, particularly in our Credit Group, regularly borrow a substantial amount of their capital. The use of leverage poses a significant degree of risk and enhances the possibility of a significant loss in the value of the investment portfolio. A fund may borrow money from time to time to purchase or carry securities or may enter into derivative transactions with counterparties that have embedded leverage. The interest expense and other costs incurred in connection with such borrowing may not be recovered by appreciation in the securities purchased or carried and will be lost, and the timing and magnitude of such losses may be accelerated or exacerbated, in the event of a decline in the market value of such securities. Gains realized with borrowed funds may cause the fund’s net asset value to increase at a faster rate than would be the case without borrowings. However, if investment results fail to cover the cost of borrowings, the fund’s net asset value could also decrease faster than if there had been no borrowings. In addition, as a business development company registered under the Investment Company Act, ARCC is currently permitted to incur indebtedness or issue senior
securities only in amounts such that its asset coverage ratio equals at
least 200%150% after each such issuance or issuance. ARCC’s ability to pay dividends will be restricted if its asset coverage ratio falls below at least 200%150% and any amounts that it uses to service its indebtedness are not available for dividends to its common stockholders. An increase in interest rates could also decrease the value of fixed-rate debt investments that our funds make. Any of the foregoing circumstances could have a material adverse effect on our financial condition, results of operations and cash flow.
Some of our funds may invest in companies that are highly leveraged, which may increase the risk of loss associated with those investments.
Some of our funds may invest in companies whose capital structures involve significant leverage. For example, in many non-distressed private equity investments, indebtedness may be as much as 75% or more of a portfolio company’s or real estate asset’s total debt and equity capitalization, including debt that may be incurred in connection with the investment, whether incurred at or above the investment-level entity. In distressed situations, indebtedness may exceed 100% or more of a portfolio company’s capitalization. Investments in highly leveraged entities are inherently more sensitive to declines in revenues, increases in expenses and interest rates and volatile or adverse economic, market and industry developments. Additionally, the debt positions acquired by our funds may be the most junior in what could be a complex capital structure, and thus subject us to the greatest risk of loss.
Investmentsloss in highly leveraged entities are also inherently more sensitive to declines in revenues, increases in expenses and interest rates and volatilethe event of insolvency, liquidation, dissolution, reorganization or adverse economic, market and industry developments.bankruptcy of one of these companies. Furthermore, the incurrence of a significant amount of indebtedness by an entity could, among other things:
•subject the entity to a number of restrictive covenants, terms and conditions, any violation of which could be viewed by creditors as an event of default and could materially impact our ability to realize value from the investment;
•allow even moderate reductions in operating cash flow to render the entity unable to service its indebtedness, leading to a bankruptcy or other reorganization of the entity and a loss of part or all of our fund’s equity investment in it; and
•give rise to an obligation to make mandatory prepayments of debt using excess cash flow, which might limit the entity’s ability to respond to changing industry conditions if additional cash is needed for the response, to make unplanned but necessary capital expenditures or to take advantage of growth opportunities;
limit the entity’s ability to adjust to changing market conditions, thereby placing it at a competitive disadvantage compared to its competitors that have relatively less debt;
limit the entity’s ability to engage in strategic acquisitions that might be necessary to generate attractive returns or further growth; and
limit the entity’s ability to obtain additional financing or increase the cost of obtaining such financing, including for capital expenditures, working capital or other general corporate purposes.
As a result, the risk of loss associated with a leveraged entity is generally greater than for companies with comparatively less debt. For example, a number of investments consummated by private equity sponsors during 2005, 2006 and 2007 that utilized significant amounts of leverage subsequently experienced severe economic stress and, in certain cases, defaulted on their debt obligations due to a decrease in revenues and cash flow precipitated by the subsequent economic downturn during 2008 and 2009. Similarly, the leveraged nature of the investments of our real estate funds increases the risk that a decline in the fair value of the underlying real estate or tangible assets will result in their abandonment or foreclosure. In addition, for taxable years beginning after December 31, 2017, the Tax Cuts and Jobs Act imposes significant limitations on the deductibility of interest expense for U.S. federal income tax purposes, which could adversely affect highly leveraged companies.
Many of our funds invest in assets that are high risk, illiquid or subject to restrictions on transfer and we may fail to realize any profits from these activities ever or for a considerable period of time.
Many of our funds invest in securities that are not publicly traded. In many cases, our funds may be prohibited by contract or by applicable securities laws from selling such securities for a period of time. Our funds generally cannot sell these securities publicly unless either their sale is registered under applicable securities laws or an exemption from such registration is available. Accordingly, our funds may be forced, under certain conditions, to sell securities at a loss. The ability of many of our funds, particularly our Private Equity Group funds, to dispose of these investments is heavily dependent on the public equity markets. For example, the ability to realize any value from an investment may depend upon the ability of the portfolio company in which such investment is held to complete an initial public offering. Even if the securities are publicly traded, large holdings of securities
can often be disposed of only over a substantial period of time. Moreover, because the investment strategy of many of our funds, particularly our Private Equity Group funds, often entails our having representation on our funds’ public portfolio company boards, our funds can effectaffect such sales only during limited trading windows, exposing the investment returns to risks of downward movement in market prices during the intended disposition period. In addition, market conditions and the regulatory environment can also delay our funds' ability to exit and realize value from their investments. For example, rising interest rates and challenging credit markets may make it difficult for potential buyers to raise sufficient capital to purchase our funds’ investments. Government policies regarding certain regulations, such as antitrust law, or restrictions on foreign investment in certain of our funds’ portfolio companies or assets can also limit our funds’ exit opportunities. The recently enacted Foreign Investment Risk Review Modernization Act (“FIRRMA”) and related regulations significantly expanded the types of transactions that are subject to the jurisdiction of the Committee on Foreign Investment in the United States (“CFIUS”). Under FIRRMA, CFIUS has the authority to review and potentially block or impose conditions on certain foreign investments in U.S. companies or real estate, which may reduce the number of potential buyers and limit the ability of our funds to exit from certain investments. In addition, our Credit Group funds may hold investments in portfolio companies of such Private Equity Group funds on which we have board representation and be restricted for extended periods of time from selling their investments. As such, we may fail to realize any profits from our investments in the funds that hold these securities for a considerable period of time or at all, and we may lose some or all of the principal amount of our investments.
Certain of our funds utilize special situation and distressed debt investment strategies that involve significant risks.
Certain of the funds in our Credit and Private Equity Groups invest in obligors and issuers with weak financial conditions, poor operating results, substantial financing needs, negative net worth and/or special competitive problems. These funds also invest in obligors and issuers that are involved in bankruptcy or reorganization proceedings. In such situations, it may be difficult to obtain full information as to the exact financial and operating conditions of these obligors and issuers. Additionally, the fair values of such investments are subject to abrupt and erratic market movements and significant price volatility if they are publicly traded securities, and are subject to significant uncertainty in general if they are not publicly traded securities. Furthermore, some of our funds’ distressed investments may not be widely traded or may have no recognized market. A fund’s exposure to such investments may be substantial in relation to the market for those investments, and the assets are likely to be illiquid and difficult to sell or transfer. As a result, it may take a number of years for the market value of such investments to ultimately reflect their intrinsic value as perceived by us.
A central feature of our distressed investment strategy is our ability to effectively anticipate the occurrence of certain corporate events, such as debt and/or equity offerings, restructurings, reorganizations, mergers, takeover offers and other transactions, that we believe will improve the condition of the business. Similarly, we perform significant analysis of the company’s capital structure, operations, industry and ability to generate income, as well as market valuation of the company and its debt, and develop a strategy with respect to a particular distressed investment based on such analysis. In furtherance of that strategy our funds seek to identify the best position in the capital structure in which to invest. If the relevant corporate event that we anticipate is delayed, changed or never completed, or if our analysis or investment strategy is inaccurate, the market price and value of the applicable fund’s investment could decline sharply.
In addition, these investments could subject a fund to certain potential additional liabilities that may exceed the value of its original investment. Under certain circumstances, payments or distributions on certain investments may be reclaimed if any such payment or distribution is later determined to have been a fraudulent conveyance, a preferential payment or similar transaction under applicable bankruptcy and insolvency laws. In addition, under certain circumstances, a lender that has inappropriately exercised control of the management and policies of a debtor may have its claims subordinated or disallowed, or may be found liable for damages suffered by parties as a result of such actions. In the case where the investment in securities of troubled companies is made in connection with an attempt to influence a restructuring proposal or plan of reorganization in bankruptcy, our funds may become involved in substantial litigation.
Our funds may be unable to deploy capital at a steady and consistent pace, which could have an adverse effect on our results of operations and future fundraising.
The pace and consistency of our funds’ capital deployment has been, and may in the future continue to be, affected by a range of factors, primarily market conditions and regulatory developments, that are beyond our control. For example, in 2016 our corporate Private Equity Group funds deployed less capital than in prior years as they exercised patience amid elevated purchase price multiples. Similarly, our special situations funds may not deploy as much capital as they target due to changing market conditions and the distressed investment opportunities available. During the same period, our AUM not yet earning fees, which we refer to as our “shadow” AUM, increased due to ongoing fundraising. While this “shadow” AUM represents significant future fee-earning potential, our inability to deploy this capital on the timeframe we expect, or at all, and on terms that we believe are attractive, would reduce or delay the management and performance fees that we would otherwise expect to earn on this capital. Any such reduction or delay would impair our ability to offset investments in additional resources that we often make to manage new capital, including hiring additional professionals. Moreover, we could be delayed in raising successor funds. The impact of any such reduction or delay would be particularly adverse with respect to funds where management fees are paid on invested capital. Any of the foregoing could have a material adverse effect on our results of operations and growth.
Certain of the funds or accounts we advise or manage are subject to the fiduciary responsibility and prohibited transaction provisions of ERISA and Section 4975 of the Code, and our businesses could be adversely affected if certain of our other funds or accounts fail to satisfy an exception under the “plan assets” regulation under ERISA.
Certain of the funds and accounts we advise or manage are subject to the fiduciary responsibility and prohibited transaction provisions of ERISA and Section 4975 of the Code. For example, we currently manage some of our funds or accounts as “plan assets” under ERISA. With respect to these funds or accounts, this results in the application of the fiduciary responsibility standards of ERISA to investments made by such funds or accounts, including the requirement of investment prudence and diversification, and the possibility that certain transactions that we enter into, or may have entered into, on behalf of these funds or accounts, in the normal course of business, might constitute or result in, or have constituted or resulted in, non-exempt prohibited transactions under Section 406 of ERISA or Section 4975 of the Code. A non-exempt prohibited transaction, in addition to imposing potential liability upon fiduciaries of an ERISA plan, may also result in the imposition of an excise tax under the Code upon a “party in interest” (as defined in ERISA) or “disqualified person” (as defined in the Code) with whom we engaged in the transaction. Some of our other funds or accounts currently qualify as venture capital operating companies (“VCOCs”) or rely on another exception under the “plan assets” regulation under ERISA and therefore are not subject to the fiduciary requirements of ERISA with respect to their assets. However, if these funds or accounts fail to satisfy the VCOC requirements for any reason, including as a result of an amendment of the relevant regulations by the U.S. Department of Labor, or another exception under the “plan assets” regulation under ERISA, such failure could materially interfere with our activities in relation to these funds or accounts or expose us to risks related to our failure to comply with the applicable requirements.
Our funds may be held liable for the underfunded pension liabilities of their portfolio companies.
Under ERISA, membersA court decision found that, in certain circumstances, an investment fund could be treated as a “trade or business” for purposes of certain “controlled groups” of “tradesdetermining pension liability under ERISA. Therefore, where an investment fund owns 80% or businesses” may be jointly and severally liable for contributions required under any member’s tax-qualified defined benefit pension plan andmore (or possibly, under certain other benefit plans. Similarly, if any member’s tax-qualified defined benefit pension plan were to terminate, underfunding at termination would be the joint and several responsibility of all controlled group members, including members whose employees did not participate in the terminated plan. Similarly, joint and several liability may be imposed for certain pension plan related obligations in connection with the complete or partial withdrawal by an employer from a multiemployer pension plan. Depending on a number of factors, including the level of ownership held by our funds in a particular portfolio company, a fund may be considered to be a membercircumstances, less than 80%) of a portfolio company’s “controlled group” for this purpose, and thus maycompany, such investment fund (and any other 80%-owned portfolio companies of such fund) might be found liable for the underfundedcertain pension liabilities of such portfolio company.
In Sun Capital Partners III L.P. v. New England Teamster and Trucking Industry Pension Fund, the First Circuit Court of Appeal held that a fund was engaged in a “trade or business” with a portfolio company to the extent the portfolio company is unable to satisfy such liabilities. Our funds may, from time to time, invest in a portfolio company that has unfunded pension fund liabilities, including structuring the investment in a manner where a fund may own an 80% or greater
interest in such a portfolio company. If a fund (or other 80%-owned portfolio companies of such fund) were deemed to be liable for purposessuch pension liabilities, this could have a material adverse effect on the operations of such fund and the companies in which such fund invests. This discussion is based on current court decisions, statute and regulations regarding control group liability under ERISA, as in effect as of the ERISA rulesdate hereof, which may change in the future as the case law and was thus liable for underfunded pension liabilities. If this decision is applied generally to private equity investing, our funds could be exposed to liability for certain benefit plan contributions, a liability that could be significant if the portfolio company’s pension plan is significantly underfunded.guidance develops.
Our funds’ performance, and our performance, may be adversely affected by the financial performance of our portfolio companies and the industries in which our funds invest.
Our performance and the performance of our funds are significantly impacted by the value of the companies in which our funds have invested. Our funds invest in companies in many different industries, each of which is subject to volatility based upon economic and market factors. The credit crisis between mid-2007 and the end of 2009 caused significant fluctuations in the value of securities held by our funds and the recent global economic recessiondownturn induced by the COVID-19 pandemic had a significant impact in overall performance activity and the demands for many of the goods and services provided by portfolio companies of the funds we advise. Although the U.S. economy has registered eightten consecutive years of growth in real GDP, there remain many obstacles to continued growth in the economy such as global geopolitical events (including the current COVID-19 pandemic), risks of inflation or deflation, rising interest rates and high debt levels, both public and private. These factors and other general economic trends are likely to affect the performance of portfolio companies in manya range of industries and, in particular, industries that anticipated thathave been adversely affected by the GDP in developed economies would quickly return to pre-crisis trend.COVID-19 pandemic. The performance of our funds, and our performance, may be adversely affected if our fund portfolio companies in these industries experience adverse performance or additional pressure due to downward trends.
The performance of our investments with underlying exposure to the commodities markets is also subject to a high degree of business and market risk, as it is dependent upon prevailing prices of commodities such as oil, natural gas and coal. Prices for oil and natural gas, for example, are subject to wide fluctuation in response to relatively minor changes in the supply and demand for oil and natural gas, market uncertainty and a variety of additional factors that are beyond our control, such as level of consumer product demand, the refining capacity of oil purchasers, weather conditions, government regulations, the price and availability of alternative fuels, political conditions, foreign supply of such commodities and overall economic conditions. It is common in making
investments with underlying exposure to the commodities markets to deploy hedging strategies to protect against pricing fluctuations but such strategies may or may not protect our investments. Declining global commodity prices have impacted the value of securities held by our funds. Continued volatility could result in lower returns than we anticipated at the time certain of our investments were made. As of December 31, 2020, approximately 2% of our total AUM was invested in the energy (including oil and gas exploration and midstream investments) sector and approximately 2% in the retail sector that were challenged from the market disruption and volatility seen in the recent past as a result of the COVID-19 pandemic.
In respect of real estate, even though the U.S. residential real estate market has recently shown signs of stabilizing from a lengthy and deep downturn, various factors could halt or limit a recovery in the housing market and have an adverse effect on investment performance, including, but not limited to, rising mortgage interest rates, a low level of confidence in the economic recovery or the residential real estate market and recent U.S. tax law changes which limit the amount of itemized deductions for mortgage interest as well as state and local income tax.market.
Third-party investors in certain of our funds with commitment-based structures may not satisfy their contractual obligation to fund capital calls when requested by us, which could adversely affect a fund’s operations and performance.
Investors in certain of our funds make capital commitments to those funds that we are entitled to call from those investors at any time during prescribed periods. We depend on investors fulfilling and honoring their commitments when we call capital from them for those funds to consummate investments and otherwise pay their obligations when due. Any investor that did not fund a capital call would be subject to several possible penalties, including possibly having a meaningful amount of its existing investment forfeited in that fund. However, the impact of the penalty is directly correlated to the amount of capital previously invested by the investor in the fund and if an investor has invested little or no capital, for instance early in the life of the fund, then the forfeiture penalty may not be as meaningful. Investors may also negotiate for lesser or reduced penalties at the outset of the fund, thereby limiting our ability to enforce the funding of a capital call. Third-party investors in private equity and real estate funds typically use distributions from prior investments to meet future capital calls. In cases where valuations of existing investments fall and the pace of distributions slows, investors may be unable to make new commitments to third-party managed investment funds such as those advised by us.us using distributions they received from prior fund investments. A failure of investors to honor a significant amount of capital calls for any particular fund or funds could have a material adverse effect on the operation and performance of those funds. The risk is more prevalent with retail investors, which is an area where we are seeking to expand our distribution capabilities.
Certain of our investment funds may utilize subscription lines of credit to fund investments prior to the receipt of capital contributions from the fund’s investors. As capital calls made to a fund’s investors are delayed when using a subscription line of credit, the investment period of such investor capital is shortened, which may increase the net internal rate of return of an investment fund. However, since interest expense and other costs of borrowings under subscription lines of
credit are an expense of the investment fund, the investment fund’s net multiple of invested capital will be reduced, as will the amount of carried interest generated by the fund. Any material reduction in the amount of carried interest generated by a fund will adversely affect our revenues.
Our funds make investments in companies that are based outside of the United States, which may expose us to additional risks not typically associated with investing in companies that are based in the United States.
Some of our funds invest a portion of their assets in the equity, debt, loans or other securities of issuers located outside the United States, including Europe and Asia, while certain of our funds invest substantially all of their assets in these types of securities, and we expect that international investments will increase as a proportion of certain of our funds’ portfolios in the future. Investments in non-U.S. securities involve certain factors not typically associated with investing in U.S. securities, including risks relating to:
•our funds’ abilities to exchange local currencies for U.S. dollars and other currency exchange matters, including fluctuations in currency exchange rates and costs associated with conversion of investment principal and income from one currency into another;
•controls on, and changes in controls on, foreign investment and limitations on repatriation of invested capital;
•less developed or less efficient financial markets than exist in the United States, which may lead to price volatility and relative illiquidity;
•the absence of uniform accounting, auditing and financial reporting standards, practices and disclosure requirements and less government supervision and regulation;
•changes in laws or clarifications to existing laws (and changes in administrative practices) that could impact our tax treaty positions, which could adversely impact the returns on our investments;
•differences in legal and regulatory environments, particularly with respect to bankruptcy and reorganization, labor and employment laws, less developed corporate laws regarding fiduciary duties and the protection of investors and less reliable judicial systems to enforce contracts and applicable law;
•political hostility to investments by foreign or private equity investors;
•less publicly available information in respect of companies in non-U.S. markets;
•reliance on a more limited number of commodity inputs, service providers and/or distribution mechanisms;
•higher rates of inflation;
•higher transaction costs;
•difficulty in enforcing contractual obligations;
•fewer investor protections;
•limitations on the deductibility of interest and other financing costs and expenses for income tax purposes in certain jurisdictions;
•certain economic and political risks, including potential exchange control regulations and restrictions on our non-U.S. investments and repatriation of capital, potential political, economic or social instability, the possibility of nationalization or expropriation or confiscatory taxation and adverse economic and political developments; and
•the imposition of non-U.S. taxes or withholding taxes on income and gains recognized with respect to such securities.
While our funds will take these factors into consideration in making investment decisions, including when hedging positions, there can be no assurance that adverse developments with respect to these risks will not adversely affect our funds that invest in securities of non-U.S. issuers. In addition, certain of these funds are managed outside the United States, which may increase the foregoing risks. The Tax Cuts and Jobs Act imposes a one-time tax on a U.S. shareholder’s pro rata share of net accumulated untaxed earnings and profits of certain foreign subsidiaries (measured as of November 2, 2017 or December 31, 2017, whichever is greater). In addition, the Tax Cuts and Jobs Act also taxes (at reduced rates) U.S. shareholders on their pro rata share of “global intangible low-taxed income” earned in taxable years beginning after December 31, 2017 by certain of their foreign subsidiaries (generally the excess of an implied 10% rate of return on the subsidiaries’ adjusted bases in tangible business assets), regardless of whether the underlying earnings are repatriated.
Many of our funds make investments in companies that we do not control.
Investments by many of our funds will include debt instruments and equity securities of companies that we do not control. Such instruments and securities may be acquired by our funds through trading activities or through purchases of
securities from the issuer. In addition, our funds may seek to acquire minority equity interests more frequently and may also dispose of a portion of their majority equity investments in portfolio companies over time in a manner that results in the funds retaining a minority investment. Furthermore, while certain of our funds may make “toe-hold” distressed debt investments in a company with the intention of obtaining control, there is no assurance that a control position may be obtained and such fund may retain a minority investment. Those investments will be subject to the risk that the company in which the investment is made may make business, financial or management decisions with which we do not agree or that the majority stakeholders or the management of the company may take risks or otherwise act in a manner that does not serve our interests. If any of the foregoing were to occur, the values of the investments held by our funds could decrease and our financial condition, results of operations and cash flow could suffer as a result.
Increased regulatory scrutiny and uncertainty with regard to expense allocation may increase risk of harm.
While we historically have and will continue to allocate the expenses of our funds in good faith and in accordance with the terms of the relevant fund agreements and our expense allocation policy in effect from time to time, due to increased regulatory scrutiny of expense allocation policies in the private investment funds realm, there is no guarantee that our policies and practices will not be challenged by our supervising regulatory bodies. If we or our supervising regulators were to determine that we have improperly allocated such expenses, we could be required to refund amounts to the funds and could be subject to regulatory censure, litigation from our fund investors and/or reputational harm, each of which could have a material adverse effect on our financial condition.
We may need to pay "“clawback”“clawback” or “contingent repayment”obligations if and when they are triggered under the governing agreements with our funds.
Generally, if at the termination of a fund (and increasinglyand in certain cases at interim points in the life of a fund),fund, the fund has not achieved investment returns that (in most cases) exceed the preferred return threshold or (in all cases) the general partner receives net profits over the life of the fund in excess of its allocable share under the applicable partnership agreement, we will be obligated to repay an amount equal to the excess of amounts previously distributed to us over the amounts to which we are ultimately entitled. This obligation is known as a “clawback"“clawback” or contingent repayment obligation. Due in part to our investment performance and the fact that our carried interest is generally determined on a liquidation basis, as of December 31, 2017, 20162020, 2019 and 2015,2018, if the funds were liquidated at their fair values at that date, there would have been no contingent repayment obligation or liability. There can be no assurance that we will not incur a contingent repayment obligation in the future. At December 31, 2017, 20162020, 2019 and 2015,2018, had we assumed all existing investments were worthless, the amount of carried interest, net of tax distributions, subject to contingent repayment would
have been approximately $476.1$326.4 million, $418.3$233.4 million and $322.2$469.0 million, respectively, of which approximately $370.0$252.4 million, $323.9$175.1 million and $247.9$364.4 million, respectively, is reimbursable to the Company by certain professionals. Although a contingent repayment obligation is several to each person who received a distribution, and not a joint obligation, if a recipient does not fund his or her respective share of a contingent repayment obligation, we may have to fund such additional amounts beyond the amount of carried interest we retained, although we generally will retain the right to pursue remedies against those carried interest recipients who fail to fund their obligations. We may need to use or reserve cash to repay such contingent repayment obligations instead of using the cash for other purposes. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Contingent Obligations,” Note 2 “SummaryObligations”, “Note 2. Summary of Significant Accounting Policies” and Note 13 “Commitments“Note 9. Commitments and Contingencies” to the consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K.
We derive a substantial portion of our revenues from funds managed pursuant to management agreements that may be terminated or fund partnership agreements that permit fund investors to request liquidation of investments in our funds on short notice.
The terms of our funds generally give either the manager of the fund or the fund itself the right to terminate our investment management agreement with the fund. However, insofar as we control the general partners of our funds that are limited partnerships, the risk of termination of investment management agreement for such funds is limited, subject to our fiduciary or contractual duties as general partner. This risk is more significant for certain of our funds that have independent boards of directors.
With respect to our funds that are not exempt from registration under the Investment Company Act, each fund’s investment management agreement must be approved annually by (a) such fund’s board of directors or by the vote of a majority of such fund’s stockholders and (b) the majority of the independent members of such fund’s board of directors and, in certain cases, by its stockholders, as required by law. The funds’ investment management agreements can also be terminated by the majority of such fund’s stockholders. Termination of these agreements would reduce the fees we earn from the relevant funds, which could have a material adverse effect on our results of operations. Currently, ARDC, a registered investment company
under the Investment Company Act, and ARCC, a registered investment company that has elected to be treated as a business development company under the Investment Company Act, are subject to these provisions of the Investment Company Act.
Third-party investors in many of our funds have the right to remove the general partner of the fund and to terminate the investment period under certain circumstances. In addition, the investment management agreements related to our separately managed accounts may permit the investor to terminate our management of such accounts on short notice. These events would lead to a decrease in our revenues, which could be substantial.
The governing agreements of many of our funds provide that, subject to certain conditions, third-party investors in those funds have the right to remove the general partner of the fund or terminate the fund, including in certain cases without cause by a simple majority vote. Any such removal or dissolution could result in a cessation in management fees we would earn from such funds and/or a significant reduction in the expected amounts of performance feesincome from those funds. Performance feesincome could be significantly reduced as a result of our inability to maximize the value of investments by a fund during the liquidation process or in the event of the triggering of a “contingent repayment"repayment” obligation. Finally, the applicable funds would cease to exist after completion of liquidation and winding-up.
In addition, the governing agreements of many of our funds provide that, subject to certain conditions, third-party investors in those funds have the right to terminate the investment period of the fund, including in certain cases without cause. Such an event could have a significant negative impact on our revenue, net incomeearnings and cash flow of such fund. The governing agreements of our funds may also provide that upon the occurrence of events, including in the event that certain “key persons” in our funds do not meet specified time commitments with regard to managing the fund, investors in those funds have the right to vote to terminate the investment period, including in certain cases by a simple majority vote in accordance with specified procedures. In addition to having a significant negative impact on our revenue, net incomeearnings and cash flow, the occurrence of such an event with respect to any of our funds would likely result in significant reputational damage to us and could negatively impact our future fundraising efforts.
We currently manage a portion of investor assets through separately managed accounts whereby we earn management fees and performance fees,income, and we intend to continue to seek additional separately managed account mandates. The investment management agreements we enter into in connection with managing separately managed accounts on behalf of certain clients may in certain cases be terminated by such clients on as little as 30 days’ prior written notice. In addition, the boards of directors of the investment management companies we manage could terminate our advisory engagement of those companies on as little as 30 days’ prior written notice. ARCC’s investment management agreement can be terminated by the majority of its stockholders upon 60 days’ prior written notice. In the case of any such terminations, the management fees and performance feesincome we earn in
connection with managing such account or company would immediately cease, which could result in a significant adverse impact on our revenues.
In addition, if we were to experience a change of control (as defined under the Investment Advisers Act or as otherwise set forth in the partnership agreements of our funds), continuation of the investment management agreements of our funds would be subject to investor consent. There can be no assurance that required consents will be obtained if a change of control occurs. In addition, with respect to our funds that are subject to the Investment Company Act, each fund’s investment management agreement must be approved annually (a) by such fund’s board of directors or by a vote of the majority of such fund’s stockholders and (b) by the independent members of such fund’s board of directors and, in certain cases, by its stockholders, as required by law. Termination of these agreements would cause us to lose the management fees and performance feesincome we earn from such funds, which could have a material adverse effect on our results of operations.
A downturn in the global credit markets could adversely affect our CLO investments.
CLOs are subject to credit, liquidity, interest rate and other risks. From time to time, liquidity in the credit markets is reduced sometimes significantly, resulting in an increase in credit spreads and a decline in ratings, performance and market values for leveraged loans. We have significant exposure to these markets through our investments in our CLO funds. CLOs invest on a leveraged basis in loans or securities that are themselves highly leveraged investments in the underlying collateral, which increases both the opportunity for higher returns as well as the magnitude of losses when compared to unlevered investments. As a result of such funds’ leveraged position, CLOs and their investors are at greater risk of suffering losses. CLOs have failed in the past and may in the future fail one or more of their “overcollateralization” tests. The failure of one or more of these tests will result in reduced cash flows that may have been otherwise available for distribution to us. This could reduce the value of our investment. There can be no assurance that market conditions giving rise to these types of consequences will not once again occur, subsist or become more acute in the future.
Our funds may face risks relating to undiversified investments.
While diversification is generally an objective of our funds, there can be no assurance as to the degree of diversification, if any, that will be achieved in any fund investments. Difficult market conditions or volatility or slowdowns affecting a particular asset class, geographic region, industry or other category of investment could have a significant adverse impact on a fund if its investments are concentrated in that area, which would result in lower investment returns. This lack of diversification may expose a fund to losses disproportionate to market declines in general if there are disproportionately greater adverse price movements in the particular investments. If a fund holds investments concentrated in a particular issuer, security, asset class or geographic region, such fund may be more susceptible than a more widely diversified investment partnership to the negative consequences of a single corporate, economic, political or regulatory event. Accordingly, a lack of diversification on the part of a fund could adversely affect a fund’s performance and, as a result, our financial condition and results of operations.
The performance of our investments may fall short of our expectations and the expectations of the investors in our funds.
Before making investments, we conduct due diligence that we deem reasonable and appropriate based on the facts and circumstances applicable to each investment. When conducting due diligence, we may be required to evaluate important and complex business, financial, tax, accounting, environmental and legal issues. The due diligence investigation that we will carry out with respect to an investment opportunity may not reveal or highlight all relevant facts that may be necessary or helpful in evaluating such investment opportunity.
Once we have made an investment in a portfolio company, our funds generally establish the capital structure on the basis of financial projections prepared by the management of such portfolio company. These projections are only estimates of future results that are based upon assumptions made at the time that the projections are developed. General economic conditions, which are not predictable, along with other factors, may cause actual performance to fall short of the projections.
Additionally, we may cause our funds to acquire an investment that is subject to contingent liabilities. Such contingent liabilities could be unknown to us at the time of acquisition or, if they are known to us, we may not accurately assess or protect against the risks that they present. Acquired contingent liabilities could thus result in unforeseen losses for our funds. In addition, in connection with the disposition of an investment in a portfolio company, a fund may be required to make representations about the business and financial affairs of such portfolio company typical of those made in connection with the sale of a business. A fund may also be required to indemnify the purchasers of such investment if any such representations are inaccurate. These arrangements may result in the incurrence of contingent liabilities by a fund, even after the disposition of an investment. Accordingly, the inaccuracy of representations and warranties made by a fund could harm such fund’s performance.
Our funds may be forced to dispose of investments at a disadvantageous time. Furthermore, we may have to waive management fees for certain of our funds in certain circumstances.
Our funds may make investments that they do not advantageously dispose of prior to the date the applicable fund is dissolved, either by expiration of such fund’s term or otherwise. Although we generally expect that investments will be disposed of prior to dissolution or be suitable for in-kind distribution at dissolution, and the general partners of the funds have only a limited ability to extend the term of the fund with the consent of fund investors or the advisory board of the fund, as applicable, our funds may have to sell, distribute or otherwise dispose of investments at a disadvantageous time as a result of dissolution. This would result in a lower than expected return on the investments and, perhaps, on the fund itself. In addition, our limited partners may require that we waive management fees during periods after the contractual term of a fund, which would reduce the amount of management fees we earn and therefore could negatively impact our revenues and results of operations.
Our real estate funds are subject to the risks inherent in the ownership and operation of real estate and the construction and development of real estate.
Investments in our real estate funds will be subject to the risks inherent in the ownership and operation of real estate and real estate-related businesses and assets. These risks include the following:
•those associated with the burdens of ownership of real property;
•general and local economic conditions;
•changes in supply of and demand for competing properties in an area (as a result, for example, of overbuilding);
•fluctuations in the average occupancy and room rates for hotel properties;
•the financial resources of tenants;
•changes in building, environmental and other laws;
•energy and supply shortages;
•various uninsured or uninsurable risks;
•liability for “slip-and-fall” and other accidents on properties held by our funds;
•natural disasters;
•changes in government regulations (such as rent control and tax laws);
•changes in real property tax and transfer tax rates;
•changes in interest rates;
•the reduced availability of mortgage funds which may render the sale or refinancing of properties difficult or impracticable;
•negative developments in the economy that depress travel activity;
•environmental liabilities;
•contingent liabilities on disposition of assets;
•unexpected cost overruns in connection with development projects;
•terrorist attacks, war and other factors that are beyond our control; and
•dependence on local operating partners.
Although real estate values have generally rebounded with the rest of the economy, other than certain high profile assets in the best markets, various factors could halt or limit a recovery in the housing market.
If our real estate funds acquire direct or indirect interests in undeveloped land or underdeveloped real property, which may often be non-income producing, they will be subject to the risks normally associated with such assets and development activities, including risks relating to the availability and timely receipt of zoning and other regulatory or environmental approvals, the cost and timely completion of construction (including risks beyond the control of our fund, such as weather or labor conditions or material shortages) and the availability of both construction and permanent financing on favorable terms. Additionally, our funds’ properties may be managed by a third party, which makes us dependent upon such third parties and
subjects us to risks associated with the actions of such third parties. Any of these factors may cause the value of the investments in our real estate funds to decline, which may have a material impact on our results of operations.
Certain of our funds invest in the power, infrastructure and energy sector which is subject to significant market volatility. As such, the performance of investments in the energy sector is subject to a high degree of business and market risk.
The power, infrastructure and energy companies in which certain of our funds invest have been and will be negatively impacted by material declines in power and energy related commodity prices and are subject to other risks, including among others, supply and demand risk, operational risk, regulatory risk, depletion risk, reserve risk, severe weather, climate change and catastrophic event risk. Commodity prices fluctuate for several reasons, including changes in market and economic conditions, the impact of weather on demand, climate initiatives, levels of domestic production and international production, policies implemented by the Organization of Petroleum Exporting Countries, power and energy conservation, domestic and foreign governmental regulation and taxation and the availability of local, intrastate and interstate transportation systems.
Investments in energy, manufacturing, infrastructure and certain other assets may expose us to increased environmental risks and liabilities that are inherent in the ownership of real assets.
Ownership of real assets in our funds or vehicles may increase our risk of liability under environmental laws that impose, regardless of fault, joint and several liability for the cost of remediating contamination and compensation for damages. In addition, changes in environmental laws or regulations or the environmental condition of an investment may create liabilities that did not exist at the time of acquisition. Even in cases where we are indemnified by a seller against liabilities arising out of violations of environmental laws and regulations, there can be no assurance as to the financial viability of the seller to satisfy such indemnities or our ability to achieve enforcement of such indemnities.
Our investments in infrastructure assets may expose us to increased risks and liabilities.
Investments in infrastructure assets may expose us to increased risks and liabilities that are inherent in the ownership of real assets. For example,
•Ownership of infrastructure assets may also present additional risk of liability for personal and property injury or impose significant operating challenges and costs with respect to, for example, compliance with zoning, environmental or other applicable laws.
•Infrastructure asset investments may face construction risks including, without limitation: (a) labor disputes, shortages of material and skilled labor, or work stoppages, (b) slower than projected construction progress and the unavailability or late delivery of necessary equipment, (c) less than optimal coordination with public utilities in the relocation of their facilities, (d) adverse weather conditions and unexpected construction conditions, (e) accidents or the breakdown or failure of construction equipment or processes; and (f) catastrophic events such as explosions, fires, terrorist activities and other similar events. These risks could result in substantial unanticipated delays or expenses (which may exceed expected or forecasted budgets) and, under certain circumstances, could prevent completion of construction activities once undertaken. Certain infrastructure asset investments may remain in construction phases for a prolonged period and, accordingly, may not be cash generative for a prolonged period. Recourse against the contractor may be subject to liability caps or may be subject to default or insolvency on the part of the contractor.
•The operation of infrastructure assets is exposed to potential unplanned interruptions caused by significant catastrophic or force majeure events. These risks could, among other effects, adversely impact the cash flows available from investments in infrastructure assets, cause personal injury or loss of life, damage property, or instigate disruptions of service. In addition, the cost of repairing or replacing damaged assets could be considerable. Repeated or prolonged service interruptions may result in permanent loss of customers, litigation, or penalties for regulatory or contractual noncompliance. Force majeure events that are incapable of, or too costly to, cure may also have a permanent adverse effect on an investment.
•The management of the business or operations of an infrastructure asset may be contracted to a third-party management company unaffiliated with us. Although it would be possible to replace any such operator, the failure of such an operator to adequately perform its duties or to act in ways that are in our best interest, or the breach by an operator of applicable agreements or laws, rules and regulations, could have an adverse effect on the investment’s financial condition or results of operations. Infrastructure investments may involve the subcontracting of design and construction activities in respect of projects, and as a result our investments are subject to the risks that contractual provisions passing liabilities to a subcontractor could be ineffective, the subcontractor fails to perform services which it has agreed to perform and the subcontractor becomes insolvent.
Infrastructure investments often involve an ongoing commitment to a municipal, state, federal or foreign government or regulatory agencies. The nature of these obligations exposes us to a higher level of regulatory control than typically imposed on other businesses and may require us to rely on complex government licenses, concessions, leases or contracts, which may be difficult to obtain or maintain. Infrastructure investments may require operators to manage such investments and such operators’ failure to comply with laws, including prohibitions against bribing of government officials, may adversely affect the value of such investments and cause us serious reputational and legal harm. Revenues for such investments may rely on contractual agreements for the provision of services with a limited number of counterparties, and are consequently subject to counterparty default risk. The operations and cash flow of infrastructure investments are also more sensitive to inflation and, in certain cases, commodity price risk. Furthermore, services provided by infrastructure investments may be subject to rate regulations by government entities that determine or limit prices that may be charged. Similarly, users of applicable services or government entities in response to such users may react negatively to any adjustments in rates and thus reduce the profitability of such infrastructure investments.
Hedging strategies may adversely affect the returns on our funds’ investments.
When managing our exposure to market risks, we may (on our own behalf or on behalf of our funds) from time to time use forward contracts, options, swaps, caps, collars, floors, foreign currency forward contracts, currency swap agreements, currency option contracts or other strategies. Currency fluctuations in particular can have a substantial effect on our cash flow and financial condition. The success of any hedging or other derivative transactions generally will depend on our ability to correctly predict market or foreign exchange changes, the degree of correlation between price movements of a derivative instrument and the position being hedged, the creditworthiness of the counterparty and other factors. As a result, while we may enter into a transaction to reduce our exposure to market or foreign exchange risks, the transaction may result in poorer overall investment performance than if it had not been executed. Such transactions may also limit the opportunity for gain if the value of a hedged position increases.
While such hedging arrangements may reduce certain risks, such arrangements themselves may entail certain other risks. These arrangements may require the posting of cash collateral at a time when a fund has insufficient cash or illiquid assets such that the posting of the cash is either impossible or requires the sale of assets at prices that do not reflect their underlying value. Moreover, these hedging arrangements may generate significant transaction costs, including potential tax costs, that reduce the returns generated by a fund. Finally, the CFTC has made several public statements that it may soon issue a proposal for certain foreign exchange products to be subject to mandatory clearing, which could increase the cost of entering into currency hedges.
Risks Related to Our Organization and Structure
If we were deemed to be an “investment company” under the Investment Company Act, applicable restrictions could make it impractical for us to continue our businesses as contemplated and could have a material adverse effect on our businesses.
An entity will generally be deemed to be an “investment company” for purposes of the Investment Company Act if:
•it is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities; or
•absent an applicable exemption, it owns or proposes to acquire investment securities having a value exceeding 40% of the value of its total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis.
We believe that we are engaged primarily in the business of providing investment management services and not primarily in the business of investing, reinvesting or trading in securities. We hold ourselves out as an asset management firm and do not propose to engage primarily in the business of investing, reinvesting or trading in securities. Accordingly, we do not believe that we are an “orthodox” investment company as defined in Section 3(a)(1)(A) of the Investment Company Act and described in the first bullet point above. Furthermore, we have no material assets other than interests in certain direct and indirect wholly owned subsidiaries (within the meaning of the Investment Company Act), which in turn have no material assets other than partnership units in the Ares Operating Group entities. These wholly owned subsidiaries are the general partners of certain of the Ares Operating Group entities and are vested with all management and control over such Ares Operating Group entities. We do not believe that the equity interests of Ares Management L.P.Corporation in its wholly owned subsidiaries or the partnership units of these wholly owned subsidiaries in the Ares Operating Group entities are investment securities. Moreover, because we believe that the capital interests of the general partners of our funds in their respective funds are neither securities nor investment securities, we believe that less than 40% of Ares Management L.P.’sCorporation’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis are composed of assets that could be considered investment securities. Accordingly, we do not believe that Ares Management L.P.Corporation is an inadvertent investment company by virtue of the 40% test in Section 3(a)(1)(C) of the Investment Company Act as described in the second bullet point above.
The Investment Company Act and the rules thereunder contain detailed parameters for the organization and operation of investment companies. Among other things, the Investment Company Act and the rules thereunder limit or prohibit transactions with affiliates, impose limitations on the issuance of debt and equity securities, generally prohibit the issuance of options and impose certain governance requirements. We intend to conduct our operations so that we will not be deemed to be an investment company under the Investment Company Act. If anything were to happen that would cause us to be deemed to be an investment company under the Investment Company Act, requirements imposed by the Investment Company Act, including limitations on capital structure, the ability to transact business with affiliates and the ability to compensate senior employees, could make it impractical for us to continue our businesses as currently conducted, impair the agreements and arrangements between and among the Ares Operating Group, us, our funds and our senior management, or any combination thereof, and have a material adverse effect on our businesses, financial condition and results of operations. In addition, we may be required to limit the amount of investments that we make as a principal or otherwise conduct our businesses in a manner that does not subject us to the registration and other requirements of the Investment Company Act.
OurDue to the disparity in voting power among the classes of our common shareholders do not electstock, holders of our general partner or, except in limited circumstances,Class A common stock will generally have no influence over matters on which holders of our common stock vote on our general partner’s directors and have limited ability to influence decisions regarding our businesses.business.
Our general partner manages allUnless otherwise provided in our certificate of incorporation and bylaws or required by the Delaware General Corporation Law (the “DGCL”) or the rules of the New York Stock Exchange (the “NYSE”), holders of our operationscommon stock vote together as a single class on all matters on which stockholders generally are entitled to vote under the DGCL. On any date on which the Ares Ownership Condition is satisfied, the shares of our Class B common stock held by the Class B Stockholder entitles it to a number of votes, in the aggregate, equal to (x) four times the aggregate number of votes attributable to the shares of our Class A common stock minus (y) the aggregate number of votes attributable to the shares of our Class C common stock. On any date on which the Ares Ownership Condition is not satisfied, the shares of our Class B common stock held by the Class B Stockholder will not be entitled to vote on any matter submitted to a vote of our stockholders. Ares Voting LLC, as the initial holder of the shares of our Class C common stock (in such capacity, the “Class C Stockholder”), is generally entitled to a number of votes equal to the number of Ares Operating Group Units held of record by each limited partner of the Ares Operating Group entities (other than us and activities. On January 31our subsidiaries). When Ares Operating Group Units are exchanged for shares of each year, our general partner will determine whetherClass A common stock, the total voting power held collectivelynumber of votes to which the shares of our Class C common stock are entitled shall be reduced by (i)the number of Ares Operating Group Units so exchanged. However, so long as the Ares Ownership Condition is satisfied, the issuance of shares of our Class A common stock would increase the number of votes to which holders of our Class B common stock are entitled. As a result, so long as the special voting shares inAres Ownership Condition is satisfied, practically all matters submitted to our stockholders will be decided by the vote of the holder of our Class B common stock, Ares Management L.P. (includingGP LLC (in such capacity, the “Class B Stockholder”), and Class C Stockholder. Our certificate of incorporation also provides that the number of authorized shares of our general partner, membersClass A common stock may be increased solely by the holders of Ares Partners Holdco LLC and their respective affiliates), (ii) then-current or former Ares personnel (including indirectly through related entities) and (iii) Ares Owners Holdings L.P. is at least 10%a majority of the voting power of theour outstanding capital stock entitled to vote thereon, voting sharestogether as a single class, and no other vote of Ares Management, L.P. (the “Ares control condition”). For purposes of determining whether the Ares control condition is satisfied, our general partner will treat as outstanding, and as held by the foregoing persons, all voting shares deliverable to such persons pursuant to equity awards granted to such persons. If the Ares control condition is satisfied, the board of directors of our general partner has no authority other than that which its member chooses to delegate to it. If the Ares control condition is not satisfied, the board of directors of our general partner will be responsible for the oversight of our business and operations. See “Item 10. Directors, Executive Officers and Corporate Governance-Limited Powers of Our Board of Directors.”
Unlike the holders of common stock in a corporation, our common shareholders have limited voting rights and have no right to remove our general partnerany class or except in the limited circumstances described below, elect the directorsseries of our general partner. Our common shareholders have no right to elect the directors of our general partner unless the Ares control condition is not satisfied. For so longstock, voting together or separately as the Ares control condition is satisfied, our general partner’s board of directors is elected in accordance with its limited liability company agreement, which provides that directors are appointed and removed by Ares Partners Holdco LLC, the member of our general partner. Ares Partners Holdco LLC is owned by the Holdco Members and managed by a board of managers, which is composed of Messrs. Arougheti, Berry, de Veer, Kaplan, McFerran, Ressler and Rosenthal. Mr. Ressler has veto power over decisions by the board of managers.class, shall be required therefor. As a result, holders of our Class A common shareholdersstock will have very limited or no ability to influence stockholder decisions, including decisions regarding our businesses.business.
The voting rights of holders of our Class A common stock are further restricted by provisions in our certificate of incorporation stating that any of our shares of stock held by a person or group that beneficially owns 20% or more of any class of stock then outstanding (other than the holders of our Class B common stock, Ares Owners Holdings L.P. (“Ares Owners”), any Holdco Member or any of their respective affiliates, or a direct or subsequently approved transferee of the foregoing) cannot be voted on any matter. The Class B Stockholder and Class C Stockholder are both exempt from this limitation.
These limits on the ability of the holders of our Class A common stock to exercise voting rights restrict the ability of the holders of our Class A common stock to influence matters subject to a vote of our stockholders.
The Holdco Members will beare able to determinesignificantly influence the outcome of those few mattersany matter that may be submitted for a vote of holders of our common shareholders.stock.
Ares Voting LLC, an entityThe Class B Stockholder and Class C Stockholder, entities wholly owned by Ares Partners Holdco LLC, which is in turn owned and controlled by the Holdco Members, holds a special voting share that provideshold the shares of our Class B common stock and the shares of our Class C common stock, respectively. On any date on which the Ares Ownership Condition is satisfied, the shares of our Class B common stock held by the Class B Stockholder entitles it withto a number of votes, in the aggregate, equal to (x) four times the aggregate number of votes attributable to the shares of our Class A common stock minus (y) the aggregate number of votes attributable to the shares of our Class C common stock. On any date on which the Ares Ownership Condition is not satisfied, the shares of our Class B common stock held by the Class B Stockholder will not be entitled to vote on any matter that may be submitted forto a vote of our stockholders. The Class C Stockholder, as the holder of our Class C common shareholders (voting together asstock, is entitled to a single class on all such matters), that isnumber of
votes equal to the aggregate number of Ares Operating Group Units held of record by theeach limited partnerspartner of the Ares Operating Group entities that do not hold a special voting share. The(other than us and our subsidiaries). In addition, Ares Partners Holdco Members, throughLLC, in its capacity as general partner of Ares Owners, Holdings L.P. andis entitled to direct the special voting sharevote of all the shares of our Class A common stock held by Ares Voting LLC, hold approximately 71.59% of the voting power of Ares Management, L.P.Owners. Accordingly, the Holdco Members have sufficient voting power to determine the outcome of those few matters that may be submitted for a vote of our common shareholders.stockholders.
OurFurthermore, our certificate of incorporation provides that special meetings of our stockholders may be called at any time only by or at the direction of our board of directors, a record holder of our Class B common shareholders’ voting rights are further restricted by the provision in our partnership agreement that states that any common shares held by a person that beneficially owns 20%stock or stockholders representing 50% or more of anythe voting power of the outstanding stock of the class or classes of stock which are entitled to vote at such meeting. Our Class A common stock and our Class C common stock are considered the same class of common stock for this purpose.
Each year, our board of directors determines whether, as of January 31, the total voting power held by (i) holders of our Class C common stock, (ii) then-current or former Ares personnel (including indirectly through related entities) and (iii) Ares Owners, without duplication, is at least 10% of the voting power of the shares of our Class A common stock and the shares of our Class C common stock, voting together as a single class (the “Designated Stock”) (the “Ares Ownership Condition”). For purposes of determining whether the Ares Ownership Condition is satisfied, our board of directors will treat as outstanding, and as held by the foregoing persons, all shares of our common shares then outstanding (other than our general partner,stock deliverable to such persons pursuant to equity awards granted to such persons. The Ares Ownership Condition is currently satisfied because Ares Owners Holdings L.P.,owns a membernumber of Ares Partners Holdco LLC or their respective affiliates, a direct or subsequently approved transfereeshares of our general partner or its affiliates or a person who acquiredClass A common stock and Ares Operating Group Units such commonthat the Class C Stockholder and Ares Owners control over 70% of the voting power of the Designated Stock. In addition, certain Ares personnel (including the Holdco Members) also hold shares with the prior approval of our general partner) cannotClass A common stock and are entitled to shares of our Class A common stock pursuant to equity awards. All such additional shares of our Class A common stock would be voted on any matter. In addition,considered in determining whether the Ares Ownership Condition is satisfied.
If the Ares Ownership Condition is satisfied, our partnership agreement contains provisions limitingcertificate of incorporation provides that our board of directors will be divided into two classes: Class I directors and Class II directors. Mr. Antony P. Ressler, a Holdco Member, is the abilityonly Class I director and will continue to be a Class I director until his ownership of our common shareholders to call meetings or to acquire information about our operations,stock decreases below certain specified thresholds. All other directors are Class II directors. Furthermore, so long as well as other provisions limiting the abilityAres Ownership Condition is satisfied, (x) a quorum for the transaction of business at any meeting of our common shareholders to influence the manner or directionboard of directors and (y) any act of our management. Furthermore,board of directors, requires a majority of the common shareholders are not be entitled to dissenters’ rightsboard of appraisal underdirectors, which majority must include the Class I director. This effectively provides Mr. Ressler a veto right over all actions taken by our partnership agreement or applicable Delaware law in the eventboard of a merger or consolidation, a sale of substantially all of our assets or any other transaction or event.
directors.
As a result of these matters and the provisions referred to under “-Our“-Due to the disparity in voting power among the classes of our common shareholders do not electstock, holders of our general partner or, except in limited circumstances,Class A common stock will generally have no influence over matters on which holders of our common stock vote on our general partner’s directors and have limited ability to influence decisions regarding our businesses,business,” holders of our Class A common shareholdersstock may be deprived of an opportunity to receive a premium for their shares of our Class A common sharesstock in the future through a sale of Ares Management L.P.,Corporation, and the trading prices of shares of our Class A common sharesstock may be adversely affected by the absence or reduction of a takeover premium in the trading price.
Potential conflicts of interest may arise among the Class B Stockholder and the Class C Stockholder, on the one hand, and the holders of our general partner, its affiliates Class A common stock and/or associatespreferred stock, on the other hand.
The Class B Stockholder and us. Our general partnerthe Class C Stockholder are controlled by the Holdco Members, certain of whom also serve on our board of directors and its affiliates and associates have limited fiduciary duties to us and our preferred and common shareholders, which may permit them to favor their own interests to the detrimentall of us and our preferred and common shareholders.
Conflictswhom serve as executive officers. As a result, conflicts of interest may arise among our general partner or its affiliates or associates,the Class B Stockholder and the Class C Stockholder, and their respective controlling persons, on the one hand, and us and the holders of our Class A common stock and/or our preferred and common shareholders,stock, on the other hand. As a result of these conflicts, our general partner, which is wholly owned by Ares Partners Holdco LLC, which is in turn owned
The Class B Stockholder and controlled bythe Class C Stockholder, and thereby the Holdco Members, may favor its own interestshave the ability to influence our business and affairs through their ownership of the shares of our Class B common stock and the interestsshares of its affiliatesour Class C common stock, respectively, and provisions under our certificate of incorporation requiring the approval of the holders of our Class B common stock for certain corporate actions. Due to the disparity in voting power among the classes of our common stock, the Class B Stockholder and the Class C Stockholder will effectively control the election of directors while the Ares Ownership Condition is satisfied, and holders of our Class A common stock will generally have limited ability to elect directors and no ability to remove any of our directors, with or associates (includingwithout cause.
As such, the Class B Stockholder and Class C Stockholder, and thereby the Holdco Members) over our interests orMembers, have the interestsability to indirectly, and in some cases directly, influence the determination of our preferred and common shareholders. These conflicts include, among others, the following:
our general partner determines the amount and timing of ourthe Ares Operating Group’s investments and dispositions, cash expenditures, including those relating to compensation, indebtedness, issuances of additional partnershippartner interests, tax liabilities and amounts of reserves, each of which can affect the amount of cash that is available for distribution to our common shareholders;holders of Ares Operating Group Units.
our general partner, in resolving
In addition, conflicts may arise relating to the selection and structuring of interest, is entitled to take into account only such factors as it determines in its sole discretion to be relevant, reasonableinvestments or appropriate under the circumstances, which may include factors affecting partiestransactions, declaring dividends and other than us and our preferred and common shareholders (including the Holdco Members), which has the effect of limiting its duties (including fiduciary duties) to us and our preferred and common shareholders.distributions. For example, our subsidiaries that serve as the general partnerscertain of our funds have fiduciaryprincipals and contractual obligations to the investors in those funds, as a result of which we expect to regularly take actions in a manner consistent with such duties and obligations but that might adversely affect our results of operations or cash flow;
because our senior professional owners indirectly hold their Ares Operating Group Units through an entity thatAres Owners, which, unlike us, is not subject to corporate income taxationtaxation. See “-Tax consequences to the direct and indirect holders of Ares Management, L.P.Operating Group Units or to general partners in our funds may give rise to conflicts of interests.”
Certain actions by our board of directors require the approval of the Class B Stockholder, which is controlled by the Holdco Members.
Although the affirmative vote of a majority of our directors (which, so long as the Ares Ownership Condition is satisfied, must include the Class I director) is required for any action to be taken by our board of directors, certain specified actions will be subjectalso require the approval of the Class B Stockholder, which is controlled by the Holdco Members. These actions consist of the following:
•certain amendments to corporate income taxation, conflicts may arise between our senior professional owners and Ares Management, L.P.certificate of incorporation (including amendments to the definition of “Ares Ownership Condition” therein), or the amendment or repeal, in whole or in part, of certain provisions of our bylaws relating to our board of directors and officers (including the selection, structuringadoption of any provision inconsistent therewith);
•the sale or exchange of all or substantially all of our and dispositionour subsidiaries’ assets, taken as a whole, in a single transaction or a series of investmentsrelated transactions; and
•the merger, consolidation or other combination of our company with or into any other person.
As a “controlled company,” we qualify for some exemptions from the corporate governance and other matters;requirements of the NYSE.
otherWe are a “controlled company” within the meaning of the corporate governance standards of the NYSE. Under the NYSE rules, a company of which more than as set forth in50% of the fair competition, non-solicitationvoting power for the election of directors is held by an individual, group or another company is a “controlled company” and confidentiality agreements to which the Holdco Members are subject, which may not be enforceable, affiliates of our general partnerelect, and existing and former personnel employed by our general partner are not prohibited from engaging in other businesses or activities, including those that might be in direct competition with us;
our general partner and its affiliates and associates have limited their liability and reduced or eliminated their duties (including fiduciary duties) under our partnership agreement, while also restricting the remedies available to our preferred and common shareholders for actions that, without these limitations, might constitute breaches of duty (including fiduciary duty). In addition, we have agreedelected, not to indemnify our general partnercomply with certain corporate governance requirements of the NYSE, including the requirements: (i) that the listed company have a nominating and its affiliatescorporate governance committee that is composed entirely of independent directors, (ii) that the listed company have a compensation committee that is composed entirely of independent directors, and associates (including(iii) that the Holdco Members)compensation committee be required to the fullest extent permitted by law, except with respect to conduct involving bad faith or criminal intent. By purchasing our preferredconsider certain independence factors when engaging compensation consultants, legal counsel and common shares,other committee advisers. Accordingly, holders of our preferredClass A common stock do not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NYSE.
Our certificate of incorporation states that the Class B Stockholder is under no obligation to consider the separate interests of our other stockholders and common shares have agreed and consentedcontains provisions limiting the liability of the Class B Stockholder.
Due to the disparity in the voting power of the classes of our common stock, holders of our Class A common stock will generally have no influence over matters on which holders of our common stock vote. As a result, on any date on which the Ares Ownership Condition is satisfied, nearly all matters submitted to a vote of the holders of our common stock will be determined by the vote of the Class B Stockholder. Although controlling stockholders may owe duties to minority stockholders, our certificate of incorporation contains provisions set forthlimiting the duties owed by the Class B Stockholder and contains provisions allowing the Class B Stockholder to favor its own interests and the interests of its controlling persons over us and the holders of our Class A common stock. Our certificate of incorporation contains provisions stating that the Class B Stockholder is under no obligation to consider the separate interests of our other stockholders (including the tax consequences to such stockholders) in deciding whether or not to cause us to take (or decline to take) any action as well as provisions stating that the Class B Stockholder shall not be liable to our partnership agreement, including the provisions regardingother stockholders for monetary damages or equitable relief for losses sustained, liabilities incurred or benefits not derived by such stockholders in connection with such decisions. See “-Potential conflicts of interest situations that, inmay arise among the absence of such provisions, might constitute a breach of fiduciary or other duties under applicable state law;
our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered, or from entering into additional contractual arrangements with any of these entities on our behalf, so long as
the terms of any such additional contractual arrangements are agreed to by our general partner in good faith as determined under our partnership agreement;
our general partner determines how much we pay for acquisition targetsClass B Stockholder and the structure of such consideration, including whether to incur debt to fundClass C Stockholder, on the transaction, whether to issue shares as considerationone hand, and the number of shares to be issued and the amount and timing of any earn-out payments;
the sole memberholders of our general partner determines whether to allow senior professionals to exchange their shares Class A common stock and/or waive certain restrictions relating to such shares;
our general partner determines how much debt we incur and that decision may adversely affect our credit ratings;
our general partner determines which costs incurred by it and its affiliates are reimbursable by us;
our general partner controlspreferred stock, on the enforcement of obligations owed to us by it and its affiliates; and
our general partner decides whether to retain separate counsel, accountants or others to perform services for us.
See “Item 13. Certain Relationships and Related Transactions, and Director Independence.other hand.”
Our partnership agreement contains provisions that reduce or eliminate duties (including fiduciary duties) of our general partner and its affiliates and associates and limit remedies available to preferred and common shareholders for actions that might otherwise constitute a breach of duty. It is difficult for a preferred and common shareholder to successfully challenge a resolution of a conflict of interest by our general partner or by its conflicts committee.
Our partnership agreement contains provisions that waive or consent to conduct by our general partner or its affiliates or associates that might otherwise raise issues about compliance with fiduciary duties or applicable law. For example, our partnership agreement provides that when our general partner is acting in its individual capacity, as opposed to in its capacity as our general partner, it or any of its affiliates or associates causing it to do so may act without any duties (including fiduciary duties) or obligations to us or our preferred and common shareholders whatsoever. When our general partner, in its capacity as our general partner, is permitted to or required to make a decision in its “sole discretion” or “discretion” or under a grant of similar authority or latitude or pursuant to any provision not subject to an express standard of “good faith,” then our general partner is entitled to consider only such interests and factors as it desires, including its own interests or the interests of the Holdco Members, and has no duty or obligation (fiduciary or otherwise) to give any consideration to any interest of or factors affecting us or any preferred and common shareholders and is not subject to any different standards imposed by our partnership agreement, or otherwise existing at law, in equity or otherwise. These provisions are expressly permitted by Delaware law. Unless our general partner breaches its obligations pursuant to our partnership agreement, we and our preferred and common shareholders do not have any recourse against our general partner even if our general partner were to act in a manner that was inconsistent with traditional fiduciary duties. Furthermore, even if there has been a breach of our partnership agreement, our partnership agreement provides that our general partner and its members, managers, officers and directorsThe Class B Stockholder will not be liable to us or holders of our preferredClass A common stock for any acts or omissions unless there has been a final and non-appealable judgment determining that the Class B Stockholder acted in bad faith or with criminal intent, and we have also agreed to indemnify other designated persons to a similar extent.
Even if there is deemed to be a breach of the obligations set forth in our certificate of incorporation, our certificate of incorporation provides that the Class B Stockholder will not be liable to us or the holders of our Class A common shareholdersstock for any acts or omissions unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that, in respect of the general partner or its members, managers, officers or directorsmatter in question, the Class B Stockholder acted in bad faith or with criminal intent. These modifications
provisions are detrimental to the preferred andholders of our Class A common shareholdersstock because they restrict the remedies available to preferred and common shareholdersour stockholders for actions that without those limitations might constitute breaches of duty (including fiduciary duty).the Class B Stockholder.
Whenever a potential conflict of interest exists between us, anyIn addition, we have agreed to indemnify and hold harmless (a) each member of our subsidiariesboard of directors and each of our officers, (b) each holder of record of our Class B common stock, (c) Ares Management GP LLC, in its capacity as the former general partner of our company when we were a Delaware limited partnership, and any successor or permitted assign, (d) any person who is or was a “tax matters partner” (as defined in the Section 6231 of the Code prior to amendment by P.L. 114-74) or “partnership representative” (as defined in Section 6223 of the Code after amendment by P.L. 114-74), member, manager, officer or director of any holder of record of our Class B common stock or Ares Management GP LLC, (e) any member, manager, officer or director of any holder of record of our Class B common stock or Ares Management GP LLC who is or was serving at the request of any holder of record of our Class B common stock or Ares Management GP LLC as a director, officer, manager, employee, trustee, fiduciary, partner, tax matters partner, partnership representative, member, representative, agent or advisor of another person (collectively, the “Indemnitees”), to the fullest extent permitted by law, on an after tax basis from and against any and all losses, claims, damages, liabilities, joint or several, expenses (including legal fees and expenses), judgments, fines, penalties, interests, settlements or other amounts arising from any and all threatened, pending or completed claim, demand, action, suit or proceeding, whether civil, criminal, administrative or investigative, and whether formal or informal, and including appeals, in which any Indemnitee may be involved, or is threatened to be involved, as a party or otherwise, by reason of its status as an Indemnitee, whether arising from acts or omissions to act occurring on, before or after the date of our certificate of incorporation. We have agreed to provide this indemnification unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that, in respect of the matter in question, the Indemnitee acted in bad faith or with criminal intent.
The provision of our certificate of incorporation requiring exclusive venue in the Court of Chancery in the State of Delaware for certain types of lawsuits may have the effect of discouraging lawsuits against us and our directors, officers and stockholders.
Our certificate of incorporation requires, to the fullest extent permitted by law, that any claim, demand, action, suit or proceeding, whether civil, criminal, administrative or investigative, and whether formal or informal, and including appeals, arising out of or relating in any way to our certificate of incorporation or any of our partners and our general partner or its affiliates or associates, our general partnerstock may resolve such conflictonly be brought in the Court of interest in good faith. If our general partner subjectively believes that its resolutionChancery of the conflictState of interest isDelaware or, if such court does not opposed to our best interests, then it will be conclusively deemed that its resolution was madehave subject matter jurisdiction thereof, any other court in good faith and will not be a breachthe State of our partnership agreement or any duty. A preferred or common shareholder seeking to challenge this resolution of the conflict of interest would bear the burden of overcoming such presumption.Delaware with subject matter jurisdiction. This is different from the situation with Delaware corporations, where a conflict resolution by an interested party would be presumed to be unfair and the interested party wouldprovision may have the burdeneffect of demonstrating that the resolution was fair.
Also, if our general partner obtains the approval of its conflicts committee or a majority of the voting shares, the resolution will be conclusively deemed approved bydiscouraging lawsuits against us and our preferreddirectors, officers and common shareholders and not a breach of our partnership agreement (or any agreement referred to therein) or of any duties that our general partner or its affiliates or associates may owe to us or our preferred and common shareholders. This is different from the situation with Delaware corporations, where a conflict resolution by a committee consisting solely of independent directors may, in certain circumstances, merely shift the burden of demonstrating unfairness to the plaintiff. Preferred and common shareholders are treated as having consented to the provisions
set forth in our partnership agreement, including provisions regarding conflicts of interest situations that, in the absence of such provisions, might be considered a breach of fiduciary or other duties under applicable state law. As a result, preferred and common shareholders will, as a practical matter, not be able to successfully challenge an informed decision by the conflicts committee. See “Item 13. Certain Relationships and Related Transactions, and Director Independence.”
The potential requirement to convert our financial statements from being prepared in conformity with accounting principles generally accepted in the United States to International Financial Reporting Standards may strain our resources and increase our annual expenses.
As a public entity, the SEC may require in the future that we report our financial results under International Financial Reporting Standards (“IFRS”) instead of under GAAP. IFRS is a set of accounting principles that has been gaining acceptance on a worldwide basis. These standards are published by the London-based International Accounting Standards Board and are more focused on objectives and principles and less reliant on detailed rules than GAAP. Today, there remain significant and material differences in several key areas between GAAP and IFRS which would affect us. Additionally, GAAP provides specific guidance in classes of accounting transactions for which equivalent guidance in IFRS does not exist. The adoption of IFRS is highly complex and would have an impact on many aspects of us and our operations, including, but not limited to, financial accounting and reporting systems, internal controls, taxes, borrowing covenants and cash management. It is expected that a significant amount of time, internal and external resources and expenses over a multi-year period would be required for this conversion.
The requirements of being a public entity and sustaining growth may strain our resources.
As a public entity, we are subject to the reporting requirements of the Exchange Act and requirements of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”). These requirements may place a strain on our systems and resources. The Exchange Act requires that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and procedures and internal controls over financial reporting, and requires our management and independent auditors to report annually on the effectiveness of our internal control over financial reporting. To maintain and improve the effectiveness of our disclosure controls and procedures, significant resources and management oversight is required. We have implemented procedures and processes to address the standards and requirements applicable to public companies. If we are not able to maintain the necessary procedures and processes, we may be unable to report our financial information on a timely or accurate basis, which could subject us to adverse regulatory consequences, including sanctions by the SEC or violations of applicable NYSE listing rules, and result in a breach of the covenants under the agreements governing any of our financing arrangements. Preparing our consolidated financial statements involves a number of complex manual and automated processes, which are dependent on individual data input or review and require significant management judgment. One or more of these elements may result in errors that may not be detected and could result in a material misstatement of our consolidated financial statements. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements. Confidence in the reliability of our financial statements could also suffer if our independent registered public accounting firm were to report a material weakness in our internal controls over financial reporting. This could have a material adverse effect on us and lead to a decline in the price of our common shares.
In addition, sustaining our growth also requires us to commit additional management, operational, and financial resources to identify new professionals to join the firm and to maintain appropriate operational and financial systems to adequately support expansion. These activities may divert management’s attention from other business concerns, which could have a material adverse effect on our businesses, financial condition, results of operations and cash flows.
The control of our general partner may be transferred without common shareholder consent.
Our general partner may transfer all or any part of its general partner interest without the consent of our common shareholders. Furthermore, at any time, the member of our general partner may sell or transfer all or part of its interests in our general partner without the approval of the common shareholders. A new general partner may not be willing or able to form new funds and could form funds that have investment objectives and governing terms that differ materially from those of our current funds. A new owner could also have a different investment philosophy, employ investment professionals who are less experienced, be unsuccessful in identifying investment opportunities or have a track record that is not as successful as our track record. If any of the foregoing were to occur, we could experience difficulty in making new investments, and the value of our existing investments, our businesses, our results of operations and our financial condition could materially suffer.
stockholders.
Our ability to pay distributionsdividends to the holders of our Class A common shareholdersstock may be limited by our holding company structure, applicable provisions of Delaware law and contractual restrictions or obligations.
As a holding company, our ability to pay distributionsdividends will be subject to the ability of our subsidiaries to provide cash to us. Ares Management L.P.Corporation has no material assets other than investments in the Ares Operating Group entities, either directly or through direct or indirect subsidiaries. We have no independent means of generating revenues. Accordingly, we intend to cause the Ares Operating Group entities to fund any distributionsdividends we may declare on theshares of our Class A common shares.stock. If the Ares Operating Group entities make distributions to fund such distributions,dividends, all holders of Ares Operating Group Units will be entitled to receive equivalent distributions pro rata based on their partnership interests in the Ares Operating Group.
Because we will be treated as a U.S. corporation for U.S. federal income tax purposes andwe will be subject to entity-level corporate income taxes and may be obligated to make payments under the tax receivable agreement, the amountsamount of dividends ultimately distributedpaid by us to holders of our Class A common shareholdersstock are generally expected to be less, on a per share basis, than the amounts distributed by the Ares Operating Group to the holders of Ares Operating Group Units (including us) in respect of their or our Ares Operating Group Units. In addition, each Ares Operating Group entity has issuedFor a seriesfurther discussion of preferred units (“GP Mirror Units”) with economic terms designedrelated tax consequences and risks, see “-Risks Related to generally mirror thoseTaxation-We are a corporation, and applicable taxes will reduce the amount available for dividends to holders of the Seriesour Class A Preferred Shares. The GP Mirror Units pay the same 7.00% rate per annum to us that we pay on our Series A Preferred Shares. Although income allocatedcommon stock in respect of distributions onsuch investments and could adversely affect the GP Mirror Units made to usvalue of our Class A common stockholders’ investment.”
Our dividend policy contemplates a steady quarterly dividend for each calendar year that will be subject to tax, cash distributions to holders of Series A Preferred Shares will not be reducedbased on account of any income taxes owed by us.
our after-tax fee related earnings. The declaration, payment and paymentdetermination of the amount of quarterly dividends, if any, future distributions will be at the sole discretion of our general partner, whichboard of directors, and reassessed each year based on the level and growth of our after-tax fee related earnings. We may change our distributiondividend policy at any time. There can be no assurance that any distributions,dividends, whether quarterly or otherwise, can or will be paid. Our ability to make cash distributionsdividends to holders of our Class A common shareholdersstock depends on a number of factors, including among other things, general economic and business conditions, our strategic plans and prospects, our businesses and investment opportunities, our financial condition and operating results, working capital requirements and other anticipated cash needs, contractual restrictions and obligations, including fulfilling our current and future capital commitments, legal, tax and regulatory restrictions, restrictions and other implications on the payment of distributionsdividends by us to our common shareholders
stockholders or by our subsidiaries to us, payments required to be made pursuant to the tax receivable agreement and such other factors as our general partnerboard of directors may deem relevant.
Under the Delaware Revised Uniform Limited Partnership Act (the “Delaware Limited Partnership Act”),DGCL, we may not make a distributiononly pay dividends to a partner if afterour stockholders out of (i) our surplus, as defined and computed under the distribution allprovisions of the DGCL or (ii) our liabilities, other than liabilities to partners on account of their partnership interests and liabilitiesnet profits for the fiscal year in which the recourse of creditorsdividend is limited to specific property ofdeclared and/or the partnership, would exceed the fair value of our assets.preceding fiscal year. If we were to makedo not have sufficient surplus or net profits, we will be prohibited by law from paying any such an impermissible distribution, any limited partner who received a distribution and knew at the time of the distribution that the distribution was in violation of the Delaware Limited Partnership Act would be liable to us for the amount of the distribution for three years.dividend. In addition, the terms of the Credit Facility or other financing arrangements may from time to time include covenants or other restrictions that could constrain our ability to make distributions. In addition,dividends. Furthermore, the Ares Operating Group’s cash flow may be insufficient to enable them to make required minimum tax distributions to their members and partners, in which case the Ares Operating Group may have to borrow funds or sell assets, which could have a material adverse effect on our liquidity and financial condition. Our partnership agreementcertificate of incorporation contains provisions authorizing us, subject to the approval of our stockholders, to issue additional partnership interestsclasses or series of stock that have designations, preferences, rights, powers and duties that are different from, and may be senior to, those applicable to shares of our Class A common shares on the terms and conditions determined by our general partner in its sole discretion at any time without common shareholder approval.stock.
Furthermore, by making cash distributionsdividends to our stockholders rather than investing that cash in our businesses, we risk slowing the pace of our growth, or not having a sufficient amount of cash to fund our operations, new investments or unanticipated capital expenditures, should the need arise.
The Class B Stockholder or the Class C Stockholder may transfer their interests in the shares of our Class B common stock or the shares of our Class C common stock, respectively, which could materially alter our operations.
Subject to certain restrictions outlined in our certificate of incorporation, our stock is freely transferable and the Class B Stockholder or the Class C Stockholder may transfer their shares of our Class B common stock and our Class C common stock, respectively, to a third party without the consent of the holders of any other class or series of our stock. Further, the members of the Class B Stockholder or the Class C Stockholder may sell or transfer all or part of their limited liability company interests in the Class B Stockholder or the Class C Stockholder, respectively, at any time without restriction. Any such transfer could constitute or cause a change of control under the Investment Advisers Act, the Credit Facility or other debt instruments and/or governing documents of our funds and other vehicles, which could require consents or waivers or cause defaults under any such documents. In addition, a new holder of shares of our Class B common stock or shares of our Class C common stock, or new controlling members of the Class B Stockholder or Class C Stockholder, may choose to vote for the election of directors to our board of directors who may not be willing or able to cause us to form new funds and could cause us to form funds that have investment objectives and governing terms that differ materially from those of our current funds. A new holder of our Class B common stock or our Class C Common Stock, new controlling members of the Class B Stockholder or Class C Stockholder and/or the directors they each respectively may appoint to our board of directors could also have a different investment philosophy, cause us or our affiliates to employ investment professionals who are less experienced, be unsuccessful in identifying investment opportunities or have a track record that is not as successful as our track record. If any of the foregoing were to occur, we could experience difficulty in making new investments, and the value of our existing investments, our business, our results of operations and our financial condition could materially suffer.
Our certificate of incorporation also provides us with a right to acquire shares of our Class A common stock under specified circumstances, which may adversely affect the price of shares of our Class A common stock.
Our certificate of incorporation provides that, if at any time, either (i) less than 10% of the total shares of any class of our stock then outstanding (other than our Class B common stock, our Class C common stock and our preferred stock) is held by persons other than a record holder of our Class B common stock, any person who is, was or will be a member of Ares Partners Holdco LLC or their respective affiliates or (ii) we are required to register as an investment company under the U.S. Investment Company Act of 1940, we may exercise our right to purchase shares of our Class A common stock or assign this right to a record holder of our Class B common stock or any of its affiliates. As a result, a stockholder may have his or her shares of our Class A common stock purchased from him or her at an undesirable time or price.
Other anti-takeover provisions in our charter documents could delay or prevent a change in control.
In addition to the provisions described elsewhere relating to the relative voting power of our classes of common stock, other provisions in our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a holder of our Class A common stock may consider favorable by, for example:
•permitting our board of directors to issue one or more series of preferred stock;
•providing for the loss of voting rights for certain series or classes of our capital stock;
•imposing supermajority voting requirements for certain amendments to our certificate of incorporation;
•requiring advance notice for stockholder proposals and nominations at annual and special meetings of our stockholders; and
•placing limitations on convening stockholder meetings.
These provisions may also discourage acquisition proposals or delay or prevent a change in control.
We will be required to pay the TRA Recipients for most of the benefits relating to our use of tax attributes we receive from prior and future exchanges of Ares Operating Group Units and related transactions. In certain circumstances, payments to the TRA Recipients may be accelerated and/or could significantly exceed the actual tax benefits we realize.
The holders of Ares Operating Group Units, subject to any applicable transfer restrictions and other provisions, may, on a quarterly basis, exchange their Ares Operating Group Units for shares of our Class A common sharesstock on a one-for-one basis or, at our option, for cash. A holder of Ares Operating Group Units must exchange one Ares Operating Group Unit in each of the three Ares Operating Group entities to effect an exchange for a share of Class A common sharestock of Ares Management L.P.Corporation. These exchanges are expected to result in increases (for U.S. federal income tax purposes) in the tax basis of the tangible and intangible assets of the relevant Ares Operating Group entity. These increases in tax basis generally will increase (for U.S. federal income tax purposes) depreciation and amortization deductions and potentially reduce gain on sales of assets and, therefore, reduce the amount of tax that we would
otherwise be required to pay in the future, although the IRS may challenge all or part of these deductions and tax basis increases, and a court could sustain such a challenge.
We have entered into a tax receivable agreement with certain direct and indirect holders of Ares Operating Group Units (the “TRA Recipients”) that provides for the payment by us to the TRA Recipients of 85% of the amount of cash tax savings, if any, in U.S. federal, state, local and foreign income tax or franchise tax that we actually realize (or are deemed to realize in the case of an early termination payment by us or a change of control, as discussed below) as a result of increases in tax basis and certain other tax benefits related to our entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement. The reduction in the statutory corporate tax rate from 35% to 21% would generally reduce the amount of cash tax savings and thus reduce the amount of the payments to the TRA Recipients. On the other hand, due to the Tax Election, a greater percentage of our income will be subject to corporate taxation and thus generally increase the amount payable under the tax receivable agreement. The payments we may make to the TRA Recipients could be material in amount and we may need to incur debt to finance payments under the tax receivable agreement if our cash resources are insufficient to meet our obligations under the tax receivable agreement as a result of timing discrepancies or otherwise. Assuming thatThe actual increase in tax basis (and our ability to achieve the market valuecorresponding tax benefits), as well as the amount and timing of any payments under the tax receivable agreement, will vary depending upon a number of factors, including the timing of exchanges, the price of a share of our Class A common share werestock at the time of the exchange, the extent to be equal to $20.00 per common share, which is the closing price per common share as of December 31, 2017, and that LIBOR were to be 2.11% and a federal corporate tax rate of 21%, we estimate that the aggregate amount of these termination payments would be approximately $398 million. The foregoing amount is merely an estimatesuch changes are taxable and the actualamount and timing of our income. As a result, in certain circumstances, payments to the TRA Recipients under the tax receivable agreement could differ materially.
be in excess of our cash tax savings. If the IRS were to challenge a tax basis increase (or the ability to amortize such increase), the TRA Recipients will not reimburse us for any payments previously made to them under the tax receivable agreement. Our ability to achieve benefits from any tax basis increase, and the payments to be made under the tax receivable agreement, will depend upon a number of factors, as discussed above, including the timing and amount of our future income. As a result, in certain circumstances, payments to the TRA Recipients under the tax receivable agreement could be in excess of our cash tax savings.
In addition, the tax receivable agreement provides that, upon a change of control, or if, at any time, we elect an early termination of the tax receivable agreement, our obligations under the tax receivablesreceivable agreement with respect to exchanged or acquired shares of our Class A common stock (whether exchanged or acquired before or after such change of control) would be based on certain assumptions, including that we would have sufficient taxable income to fully utilize the deductions arising from the increased tax deductions and tax basis and other benefits related to entering into the tax receivable agreement and, in the case of an early termination election, that any Ares Operating Group Units that have not been exchanged are deemed exchanged for the market value of theshares of our Class A common sharesstock at the time of termination. See “Item 13. Certain RelationshipsAssuming that the market value of a share of our Class A common stock were to be equal to $47.05, which is the closing price per share of our Class A common stock as of December 31, 2020, and Related Transactions,that LIBOR were to be 1.34% and Director Independence-Tax Receivable Agreement.”a blended federal and state corporate tax rate of 23.7%, we estimate that the aggregate amount of these termination payments would be approximately $983.2 million on the 112 million Ares Operating Group Units that have not been exchanged for Class A common stock. The foregoing amount is merely an estimate and the actual payments could differ materially.
Tax consequences to the direct and indirect holders of Ares Operating Group Units or to general partners in our funds may give rise to conflicts of interests.
As a result of the tax gain inherent in our assets held by the Ares Operating Group, at the time of this report, upon a realization event, certain direct and indirect holders of Ares Operating Group Units may incur different and potentially significantly greater tax liabilities as a result of the disproportionately greater allocations of items of taxable income and gain to such holders. As these direct and indirect holders will not receive a correspondingcorrespondingly greater distribution of cash proceeds, they may, subject to applicable fiduciary or contractual duties, have different objectives regarding the appropriate pricing, timing and other material terms of any sale, refinancing, or disposition, or whether to sell such assets at all. Decisions made with respect to an acceleration or deferral of income or the sale or disposition of assets with unrealized built-in tax gains may also influence the timing and amount of payments that are received by the TRA Recipients (including, among others, the Holdco Members and other
executive officers) under the tax receivable agreement. In general, we anticipate that earlier disposition of assets with unrealized built-in tax gains following suchan exchange will tend to accelerate such payments and increase the present value of payments under the tax receivable agreement, and disposition of assets with unrealized built-in tax gains in a tax year before an exchange generally will increase an exchanging holder’s tax liability without giving rise to any rights to any payments under the tax receivable agreement. Decisions made regarding a change of control also could have a material influence on the timing and amount of payments received by the TRA Recipients pursuant to the tax receivable agreement.
Moreover, we may receive performance income from our funds if specified returns are achieved by those funds. In certain circumstances, we may prefer to structure the performance income as a special allocation of income, which we refer to as a carried interest, rather than as an incentive fee.
The general partner of our funds may be entitled to receive carried interest from our funds and a significant portion of that carried interest may consist of long-term capital gains. Because Ares Management, L.P. will be taxable asAs a U.S. corporation, for U.S. federal income tax purposes, itwe will not receive preferential treatment for long-term capital gains.gains and we may be limited in deducting capital losses. As a result, the general partners of our funds may have interests that are not entirely aligned with our stockholders and thus, subject to their fiduciary duties to fund investors, the general partners of our funds may be incentivized to seek investment opportunities with lower pre-tax returns but higher after-tax returns taking into account the preferentialthat maximize favorable tax rates for capital gains, which may be adverse to our interests.
We are a Delaware limited partnership and as a result will qualify for and intend to rely on exceptions from certain corporate governance and other requirements under the rules of the NYSE. Further, there are certain provisions in our partnership agreement regarding exculpation and indemnification of our officers and directors that differ from the Delaware General Corporation Law in a manner that may be less protective of the interests of our shareholders.
We are a Delaware limited partnership and qualify for exceptions from certain corporate governance and other requirements of the rules of the NYSE. Pursuant to these exceptions, limited partnerships may elect not to comply with certain corporate governance requirements of the NYSE, including the requirements that (i) a majority of the board of directors of our general partner consist of independent directors, (ii) we have a nominating/corporate governance committee that is composed entirely of independent directors, (iii) we have a compensation committee that is composed entirely of independent directors and (iv) the compensation committee consider certain independence factors when engaging compensation consultants, legal counsel and other committee advisers. In addition, we are not required to hold annual meetings of our common shareholders. We have availed ourselves of these exceptions. Accordingly, holders of our common shares do not have the same protections afforded to equityholders of entities that are subject to all of the corporate governance requirements of the NYSE.
Our partnership agreement provides thattreatment to the fullest extent permitted by applicable law the directors and officers of our general partner will not be liable to us unless they act in bad faith or with criminal intent. However, under the Delaware General Corporation Law, a director or officer would be liable to us for (i) breach of duty of loyalty to us or our equityholders, (ii) intentional misconduct or knowing violations of the law that are not done in good faith, (iii) improper redemption of shares or declaration of dividend or (iv) a transaction from which the director derived an improper personal benefit. In addition, our partnership agreement provides that we indemnify the directors and officers of our general partner for acts or omissions to the fullest extent provided by law unless they act in bad faith or with criminal intent. However, under the Delaware General Corporation Law, a corporation can only indemnify directors and officers for acts or omissions if the director or officer acted in good faith, in a manner he reasonably believed to be in the best interests of the corporation, and, in criminal action, if the officer or director had no reasonable cause to believe his conduct was unlawful. Accordingly, our partnership agreement is less protective of the interests of our common shareholders, when compared to the Delaware General Corporation Law, insofar as it relates to the exculpation and indemnification of officers and directors.partners.
Risks Related to Shares of Our Common Stock and Shares of Our Preferred and Common SharesStock
The market price and trading volume of shares of our Class A common sharesstock may be volatile, which could result in rapid and substantial losses for holders of our Class A common shareholders.stock.
The market price of shares of our Class A common sharesstock may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume in shares of our Class A common sharesstock may fluctuate and cause significant price variations to occur. If the market price of shares of our Class A common sharesstock declines significantly, holders of our Class A common sharesstock may be unable to resell their shares of our Class A common sharesstock at or above their purchase price, if at all. The market price of shares of our Class A common sharesstock may fluctuate or decline significantly in the future. Some of the factors that could negatively affect the price of shares of our Class A common sharesstock or result in fluctuations in the price or trading volume of shares of our Class A common sharesstock include:
•variations in our quarterly operating results or distributions,dividends, which variations we expect will be substantial;
•our policy of taking a long-term perspective on making investment, operational and strategic decisions, which is expected to result in significant and unpredictable variations in our quarterly returns;
•our creditworthiness, results of operations and financial condition;
•the prevailing interest rates or rates of return being paid by other companies similar to us and the market for similar securities;
•failure to meet analysts’ earnings estimates;
•publication of research reports about us or the investment management industry or the failure of securities analysts to cover shares of our Class A common shares;stock;
•additions or departures of our senior professionals and other key management personnel;
•adverse market reaction to any indebtedness we may incur or securities we may issue in the future;
•changes in market valuations of similar companies;
•speculation in the press or investment community;
•changes or proposed changes in laws or regulations or differing interpretations thereof affecting our businesses or enforcement of these laws and regulations, or announcements relating to these matters;
•a lack of liquidity in the trading of shares of our Class A common shares;stock;
•announcements by our competitors of significant contracts, acquisitions, dispositions, strategic partnerships, joint ventures or capital commitments;
•adverse publicity about the asset management industry generally or, more specifically, private equity fund practices or individual scandals; and
•general market and economic, conditions.financial, geopolitical, regulatory or judicial events or conditions that affect us or the financial markets.
In the past few years, stock markets have experienced extreme price and volume fluctuations. In the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against public companies. This type of litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
An investment in our common shares is not an investment in any of our funds, and the assets and revenues of our funds are not directly available to us.
Common shareholders will not directly participate in the performance of our underlying funds, and any benefits from such performance will directly inure to investors in those funds. Our common shares are securities of Ares Management, L.P. only. While our historical consolidated financial information includes financial information, including assets and revenues, of our funds on a consolidated basis, and our future financial information will continue to consolidate certain of these funds, such assets and revenues are available to the fund and not to us except to a limited extent through management fees, performance fees, distributions and other proceeds arising from agreements with funds, as discussed in more detail in this Annual Report on Form 10-K.
The market price of shares of our Class A common sharesstock may decline due to the large number of shares of Class A common sharesstock eligible for exchange and future sale.
The market price of shares of our Class A common sharesstock could decline as a result of sales of a large number of shares of our Class A common sharesstock in the market and non-voting common stock, to the extent that sales happen in the future or the perception that such sales could occur.occur, including pursuant to Rule 10b5-1 trading plans. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell shares of our Class A common sharesstock in the future at a time and at a price that we deem appropriate. Subject to the lock-up restrictions described below, weWe may freely issue and sell in the future additional shares of our Class A common shares.stock. In addition, some of our directors and executive officers have entered into, or may enter into, Rule 10b5-1 trading plans pursuant to which they may sell shares of our Class A common stock from time to time in the future.
As of December 31, 2017,2020, our senior professional ownersprofessionals owned, indirectly, an aggregate of 117,576,663112,447,618 Ares Operating Group Units. We have entered into an exchange agreement with the holders of Ares Operating Group Units so that such holders subject to any applicable transfer and other restrictions, may up to four times each year (subject to the terms of the exchange agreement) exchange their Ares Operating Group Units for shares of our Class A common sharesstock on a one-for-one basis, subject to customary conversion rate adjustments for splits, share distributionsstock dividends and reclassifications, or, at our option, for cash. A holder of Ares Operating Group Units must exchange one Ares Operating Group Unit in each of the three Ares Operating Group entities to effect an exchange for a share of Class A common sharestock of Ares Management L.P. The common shares we issue upon such exchanges would be “restricted securities,” as defined in Rule 144 under the Securities Act, unless we register such issuances.Corporation.
Ares Owners Holdings L.P., ADIA and Alleghany (together with ADIA, the “Strategic Investors”) have has the right, under certain circumstances and subject to certain restrictions, to require us to register under the Securities Act shares of Class A common sharesstock delivered in exchange for Ares Operating Group Units or shares of Class A common sharesstock of Ares Management L.P.Corporation otherwise held by them. In addition, we may be required to make available shelf registration statements permitting sales of shares of our Class A common sharesstock into the market from time to time over an extended period. Lastly, Ares Owners Holdings L.P. and the Strategic Investors will have the ability to exercise certain piggyback registration rights in respect of shares of our Class A common sharesstock held by them in connection with registered offerings requested by other registration rights holders or initiated by us. See “Item 13. Certain Relationships and Related Transactions, and Director Independence-Investor Rights Agreement.” See “Item 11. Executive Compensation-Director Compensation-Common Shares and Ares Operating Group Units.” However, transfers may occur notwithstanding such restrictions pursuant to transactions or programs approved by our general partner.
Under our 2014 Equity Incentive Plan, As of December 31, 2020, there arewere options outstanding to purchase 20,495,0258,312,203 shares of our Class A common sharesstock and 13,751,88816,299,664 restricted sharesunits outstanding to be settled in shares of our Class A common shares,stock, both of which are subject to specified vesting requirements, and were granted to certain of our senior professionals. During the course of 2017, awards representing 1,621,592 common shares were forfeited and became available for issuanceprofessionals under the 2014 Equity Incentive Plan.Plan, as amended and restated on March 1, 2018 and as further amended and restated effective November 26, 2018 (the “Equity Incentive Plan”). As of December 31, 2017, 26,284,165 additional2020, 33,861,117 shares of our Class A common sharesstock were available for awardto be issued under our 2014 Equity Incentive Plan. We have filed twoa registration statements and intend to file more registration statementsstatement on Form S-8 with the SEC covering the shares of our Class A common sharesstock issuable under our 2014 Equity Incentive Plan. Subject to vesting and contractual lock-up arrangements (including through May 1, 2019 for restricted
such shares granted in connection withof our initial public offering.), upon effectiveness of the relevant registration statement on Form S-8, suchClass A common sharesstock are freely tradable. Vesting of those shares of restricted units would dilute the ownership interest of existing stockholders.
In addition, our partnership agreement authorizes us to issue an unlimited number of additional partnership securities and options, rights, warrants and appreciation rights relating to partnership securities for the consideration and on the terms and conditions determined by our general partner in its sole discretion without the approval of any limited partners. In accordance with the Delaware Limited Partnership Act and the provisions of our partnership agreement, we may also issue additional partnership interests that have certain designations, preferences, rights, powers and duties that are different from, and may be senior to, those applicable to our common and Series A Preferred shares. Similarly, the governing agreements of the Ares Operating Group entities authorize the direct subsidiaries of Ares Management L.P.Corporation which are the general partners of those entities to issue an unlimited number of additional units of the Ares Operating Group entity with such designations, preferences, rights, powers and duties that are different from, and may be senior to, those applicable to the Ares Operating Group Units, and which may be exchangeable for our common shares.
We cannot assure holdersshares of our Class A common stock.
Dividends on shares that our intended distributions will be paid each quarter or at all.
In conjunction with the Tax Election, we have adopted a distribution policy to provide a steady quarterly distribution for each calendar year that will be based on our after-tax fee related earnings. Starting in the second quarter of 2018, we intend to pay a $0.28 per common share distribution per quarter for the remainder of 2018. Our fixed distribution will be reassessed each year based upon the level and growth of our after-tax fee related earnings. The declaration, payment and determination of the amount of quarterly distributions, if any, will be at the sole discretion of our general partner, which may change our distribution policy at any time. We cannot assure our common shareholders that any distributions, whether quarterly or otherwise, can or will be paid. In making decisions regarding our quarterly distribution, our general partner considers general economic and business conditions, our strategic plans and prospects, our businesses and investment opportunities, our financial condition and operating results, working capital requirements and other anticipated cash needs, contractual restrictions and obligations, legal, tax, regulatory and other restrictions that may have implications on the payment of distributions by us to our common shareholders or by our subsidiaries to us, and such other factors as our general partner may deem relevant.
Distributions on the Series A Preferred SharesStock are discretionary and non-cumulative.
Distributions Dividends on shares of the Series A Preferred SharesStock are discretionary and non-cumulative. Holders of ourthe Series A Preferred SharesStock will only receive distributionsdividends when, as and if declared by theour board of directors of our general partner.directors. Consequently, if theour board of directors of our general partner does not authorize and declare a distributiondividend for a distributiondividend period, holders of the Series A Preferred SharesStock would not be entitled to receive any distributiondividend for such distributiondividend period, and such unpaid distributiondividend will not be payable in such distributiondividend period or in later distributiondividend periods. We will have no obligation to pay distributionsdividends for a distributiondividend period if theour board of directors of our general partner does not declare such distributiondividend before the scheduled record date for such period, whether or not distributionsdividends are declared or paid for any subsequent distributiondividend period with respect to shares of the Series A Preferred SharesStock or the shares of any other class of preferred sharesstock we may issue. This may result in holders of the Series A Preferred SharesStock not receiving the full amount of distributionsdividends that they expect to receive, or any distributions,dividends, and may make it more difficult to resell shares of the Series A Preferred SharesStock or to do
so at a price that the holder finds attractive. TheOur board of directors of our general partner may, in its sole discretion, determine to suspend distributionsdividends on shares of the Series A Preferred Shares,Stock, which may have a material adverse effect on the market price of shares of the Series A Preferred Shares.Stock. There can be no assurances that our operations will generate sufficient cash flows to enable us to pay distributionsdividends on shares of the Series A Preferred Shares.Stock. Our financial and operating performance is subject to prevailing economic and industry conditions and to financial, business and other factors, some of which are beyond our control.
Risks Related to Taxation
Additional proposed changes in the U.S. and foreign taxation of businesses could adversely affect us.
HM Treasury, the OECD and other government agencies in jurisdictions where we and our affiliates invest or conduct business have maintained a focus on issues related to the taxation of businesses, including multinational entities.
In the United Kingdom, the UK Criminal Finances Act 2017 creates two new separate corporate criminal offences: failure to prevent facilitation of UK tax evasion and failure to prevent facilitation of overseas tax evasion. The scope of the new law and guidance is extremely wide and could have an impact on Ares’ global businesses. Liability can be mitigated where the relevant business has in place reasonable prevention procedures. Separately, the United Kingdom has implemented transparency legislation that will require many large businesses to publish their UK tax strategies on their websites. As part of the publication requirement, organizations must disclose information on tax risk management and governance, tax planning, tax risk appetite and their approach
to Her Majesty’s Revenue and Customs. These developments show that the United Kingdom is seeking to bring corporate tax matters further into the public domain. As a result, tax matters may pose an increased reputational risk to our business.
The OECD, which represents a coalition of member countries, has issued guidance through its BEPS project that contemplates changes to longstanding international tax norms that determine each country’s jurisdiction to tax cross-border international trade and profits. In June 2017, almost 70 countries (excluding the United States) formally signed the Convention. These changes in law or guidance and additional proposals for reform, if enacted by the United States or by other countries in which we or our affiliates invest or conduct business, could adversely affect our investment returns, including, for example, by eliminating certain tax treaty benefits and increasing our tax compliance costs. Whether these or other proposals will be enacted by the United States or any foreign jurisdiction and in what form is unknown, as are the ultimate consequences of any such proposed legislation.
We will be treated asare a corporation, for U.S. federal income tax purposes, whichand applicable taxes will reduce the amount available for distributionsdividends to holders of our Class A common sharesstock in respect of such investments and could adversely affect the value of our Class A common shareholders’stockholders’ investment.
Effective March 1, 2018, Because we have elected to beare taxed as a corporation for U.S. federal income tax purposes. Wepurposes, we could be liable for significant U.S. federal income taxes and applicable state and local income taxes that would not otherwise be incurred if we were treated as a partnership for U.S. federal income tax purposes, which could reduce the amount of cash available for distributionsdividends to holders of our Class A common sharesstock and adversely affect the value of their investment.
In addition, the GP Mirror Units pay the same 7.00% rate per annum to us that we pay on ourshares of the Series A Preferred Shares.Stock. Although income allocated in respect of distributions on the GP Mirror Units made to us is subject to tax, cash distributionsdividends to holders of the Series A Preferred SharesStock will not be reduced on account of any income taxes owed by us.
Applicable U.S. and foreign tax law, regulations, or treaties, and changes in such tax laws, regulations or treaties or an adverse interpretation of these items by tax authorities could adversely affect our effective tax rate, tax liability, financial condition and results, ability to raise funds from certain foreign investors.investors, increase our compliance or withholding tax costs and conflict with our contractual obligations.
Overview of certain relevant U.S. tax laws. In addition, tax laws, regulations or treaties newly enacted or enacted in the future may cause us to revalue our net deferred tax assets and have a material change to our effective tax rate and tax liabilities. For example, the United States, Public Law No. 115-97 (the “Tax Cuts and Jobs Act”), which was enacted in December 2017 and amended various aspects of U.S. federal income tax legislation, has resulted in various changes to U.S. tax laws, including meaningful reduction to the U.S. federal corporate income tax rate, changes to the rules for the carryback and carryforward of net operating losses, changes to U.S. taxation on earnings from international business operations, certain modifications to the Section 162(m) of the Code and a partial limitation on the deductibility of business interest expense, which could have a material effect on our business operations, our funds’ investment activities and the business of our portfolio companies. More recently, in March 2020, the Families First Coronavirus Response Act (the “FFCR Act”) and the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) were enacted in response to the COVID-19 pandemic. The FFCR Act and the CARES Act contain numerous income tax provisions, such as relaxing limitations on the deductibility of interest and the use of net operating losses arising in taxable years beginning after December 31, 2017. In December 2020, the Consolidated Appropriations Act, 2021 was enacted, which expands upon the relief provided in the CARES Act and FFCR Act and includes additional tax-related provisions. We are currently evaluating the potential tax impact of the CARES Act. FFCR and Consolidated Appropriations Acts (and related legislation) on us or our business or the business of our portfolio companies. In December 2020, the U.S. Internal Revenue Service (the “IRS”) released final regulations under Section 162(m) (which are generally consistent with the proposed regulations released in December 2019), which addressed changes made by the Tax Cuts and Jobs Act and, among other things, extended the coverage of Section 162(m) to include compensation paid by a partnership for services performed for it by a covered employee of a corporation that is a partner in the partnership. The regulations may reduce the amount of tax deductions available to us. Additionally, foreign and state and local governments may continue to enact tax laws in response to the Tax Cuts and Jobs Act that could result in further changes to foreign and state and local taxation and materially affect our financial position and results of operations. We cannot predict how changes in law (like a change in corporate income tax rate), regulations, technical corrections or other guidance issued under it or conforming or non-conforming state tax rules might affect us or our business or the business of our portfolio companies. Furthermore, the IRS has recently finalized proposed regulations implementing the anti-hybrid provisions (and issued new proposed regulations providing additional guidance on such anti-hybrid provisions) and recently finalized proposed regulations (and revised certain final regulations) under the “base erosion and anti-abuse tax” (“BEAT”) provisions that were enacted as part of the Tax Cuts and Jobs Act. Whether any of the proposed regulations will be enacted by the United States or any foreign jurisdiction and in what form is unknown, as are the ultimate consequences of any such proposed regulations.
Under Sections 1471 to 1474 of the Code (such Sections, along with the Treasury Regulations promulgated thereunder, “FATCA”), a broadly defined class of foreign financial institutions are required to comply with a U.S. tax reporting regime or be subject to certain U.S. withholding taxes. The reporting obligations imposed under FATCA require foreign financial institutions to enter into agreements with the IRS to obtain and disclose information about certain account holders and investors to the IRS (or in the case of certain foreign financial institutions that are resident in a jurisdiction that has entered into
an intergovernmental agreement (the “IGA”) to implement this legislation, to comply with comparable non-U.S. laws implementing the IGA). Additionally, certain non-U.S. entities that are not foreign financial institutions are required to provide certain certifications or other information regarding their U.S. beneficial ownership or be subject to certain U.S. withholding taxes under FATCA. Failure to comply with these requirements could expose us and/or our investors to a 30% withholding tax on certain U.S. payments, (and beginning in 2019, a 30% withholding tax on gross proceeds from the sale of U.S. stocks and securities), and possibly limit our ability to open bank accounts and secure funding in the global capital markets. There are uncertainties regarding the implementation of FATCA and it is difficult to determine at this time what impact any future administrative guidance may have. The administrative and economic costs of compliance with FATCA may discourage some foreign investors from investing in U.S. funds, which could adversely affect our ability to raise funds from these investors or reduce the demand for shares of our shares.Class A common stock. Moreover, we expect to incur additional expenses related to our compliance with FATCA, which could increase our tax compliance costs generally. OtherAs discussed below, other countries, such as the UKU.K., Luxembourg, and the Cayman Islands, have implemented regimes similar to that of FATCA.FATCA, and a growing number of countries have adopted (or are in process of introducing) similar legislation designed to provide increased transparency about our investors and their tax planning and profile. One or more of these information exchange regimes are likely to apply to our funds, and we may be obligated to collect and share with applicable taxing authorities information concerning investors in our funds (including identifying information and amounts of certain income allocable or distributable to them).
Overview of certain relevant foreign tax laws. Her Majesty’s Treasury (“HM Treasury”), the Organization for Economic Co-operation and Development (the “OECD”) and other government agencies in jurisdictions where we and our affiliates invest or conduct business have maintained a focus on issues related to the taxation of businesses, including multinational entities.
The U.K. has implemented two corporate criminal offenses: failure to prevent facilitation of U.K. tax evasion and failure to prevent facilitation of overseas tax evasion. Liability under these offences can be mitigated where the relevant business has in place reasonable prevention procedures. The scope of these offences is extremely wide and could have an impact on Ares’ global businesses. The U.K. has also implemented transparency legislation that requires many large businesses to publish their U.K. tax strategies and their approach to dealing with the U.K. tax authority on their websites. Our U.K. tax policy statement is published on our website. These developments show that the U.K. is seeking to bring tax matters further into the public domain. As a result, tax matters may pose an increased reputational risk to our business. The EU, the U.K. and many other countries have implemented the OECD’s Common Reporting Standard for the automatic exchange of financial account information in tax matters (the “CRS”). EU Council Directive 2018/822 (“DAC 6”) requires mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements. As July 1, 2020 (or January 1, 2021 for jurisdictions which deferred implementation), taxpayers and their advisers may be required under DAC 6 to disclose information to tax authorities when arrangements bearing specific hallmarks involve one or more EU member states. Certain cross-border arrangements put into place beginning June 25, 2018 will also be reportable to relevant taxing authorities beginning August 31, 2020 (or February 28, 2021 for jurisdictions which deferred implementation). On December 31, 2020, the U.K. narrowed the scope of arrangements that need to be reported in the UK pursuant to DAC 6 and, in due course, intends to replace DAC 6 with the OECD Mandatory Disclosure Rules. The EU has also signed separate automatic exchange of information agreements with certain non-EU countries, under which the EU and the relevant jurisdiction will automatically exchange information on the financial accounts of each other’s residents. Investors in our funds will be required (i) to consent to the taking of any action in connection with FATCA, the CRS, DAC 6 and/or any similar other tax reporting regimes, including the disclosure of information to tax authorities which may in turn be exchanged between other tax authorities, and (ii) to agree to provide the AIFM and/or the general partner with the information they require to comply with FATCA, the CRS, DAC 6 and/or any similar other tax reporting regimes in any relevant jurisdiction. The breadth of the disclosure requirements under such tax reporting regimes will likely create costs and administrative burdens and penalties and withholding taxes could be imposed for non-compliance.
Pursuant to the OECD’s Base Erosion and Profit Shifting (“BEPS”) Project, individual jurisdictions are beginning to introduce domestic legislation implementing certain of the BEPS actions. Several of the areas of tax law (including double taxation treaties) on which the BEPS Project is focusing are relevant to the ability of our funds to efficiently realize income or capital gains and to efficiently repatriate income and capital gains from the jurisdictions in which they arise to partners and, depending on the extent to and manner in which relevant jurisdictions implement changes in such areas of tax law (including double taxation treaties), the ability of our funds to do these things may be adversely impacted. Changes in tax laws as a result of the BEPS Project may, for example, result in: (a) the restriction or loss of existing access by partners in our funds or their subsidiaries to tax relief under applicable double taxation treaties or EU directives, such as the EU Interest and Royalties Directive; (b) restrictions on permitted levels of deductibility of expenses (such as interest) for tax purposes; (c) rules affecting profit allocation and local nexus requirements, transfer pricing, or the treatment of hybrid entities/investments or (d) an increased risk of activity undertaken in a jurisdiction constituting a permanent establishment of our funds and/or any of their subsidiaries.
Many of the jurisdictions in which our funds will make investments indicated in June 2017 that they would implement the OECD’s draft Multilateral Instrument (“MLI”) which will bring into force a number relevant changes to double tax treaties. The MLI is intended to facilitate the speedy introduction by participating states of double tax treaty-related BEPS recommendations. There remains significant uncertainty as to whether and, if so, to what extent our funds or their subsidiaries may benefit from the protections afforded by such treaties and whether our funds may look to their partners in order to derive tax treaty or other benefits. This position is likely to remain uncertain for a number of years.
In July 2016, the EU adopted the EU adopted the Anti-Tax Avoidance Directive 2016/1164 (commonly referred to as “ATAD I”), which directly implements some of the BEPS Project actions points within EU law. EU member states had until December 31, 2018 to transpose ATAD I into their domestic laws (except for the provisions on exit taxation, which had to be transposed by December 31, 2019). On May 29, 2017, the Council of the EU formally adopted the Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries (commonly referred to as “ATAD II”), which came into force in member states on January 1, 2020 (subject to relevant derogations) and which contains a set of anti-hybrid rules.
ATAD II was implemented into Luxembourg domestic law by way of a law dated December 20, 2019. The anti-hybrid rules apply for fiscal years starting on or after January 1, 2020, except for the rules governing reverse hybrid mismatches which should be applicable only as of January 1, 2022. ATAD II covers inter alia hybrid mismatches and imported hybrid mismatches resulting from the different characterization of a financial instrument or an entity leading to situations of deduction without inclusion or double deduction. For hybrid mismatches resulting in a situation of deduction without inclusion, the primary rule is that the member state of the payor shall deny such deduction. For hybrid mismatches resulting in a situation of double deduction, a deduction shall only be given to the member state where the payment has its source. However, if, the jurisdiction of the payee does not deny the deduction, the secondary rule would oblige the jurisdiction of the payor to deny the deduction at the level of the payor.
If the ATAD II anti-hybrid rules apply, they can act to deny (to a greater or lesser extent) deductibility in Luxembourg corporate entities of interest/expenses. However, these anti-hybrid rules only apply to arrangements (i) between associated enterprises or (ii) that constitute “structured arrangements”. In the context of hybrid mismatches resulting from the different characterization of a financial instrument, an entity will need to hold a direct or indirect interest of 25% or more of the voting rights, capital interests or rights to share a profit to be considered an associated enterprise. The 25% requirement is replaced by a 50% requirement if the hybrid mismatch results from a different characterization of an entity (i.e. a hybrid entity). With respect to the computation of this 25% or 50% threshold requirement, ATAD II makes reference to the OECD concept of “persons acting together”, as it is specifically mentioned that for purposes of the anti-hybrid rules under ATAD II, “a person who acts together with another person in respect of the voting rights or capital ownership of an entity shall be treated as holding a participation in all of the voting rights or capital ownership of that entity that are held by the other person”. However, the Luxembourg law implementing ATAD II, which came into effect on January 1, 2020, provides that an investor in an investment fund who holds directly or indirectly less than 10% of the interest in the investment fund and who is entitled to receive less than 10% of the fund’s profits is presumed not to act together with the other investors in the same investment fund (since the investors have in principle no effective control over the investments realized by the fund), unless proved otherwise (the de minimis rule). As a consequence of this rebuttable presumption, any investor holding less than 10% in an investment fund should not be regarded as an “associated enterprise” of the fund and of any underlying Luxembourg entities. Any investor holding more than 10% will only be regarded as an “associated enterprise” if it meets the requisite threshold in its own right, or it can be demonstrated that it is acting together with other investors, which would cause it to be deemed to reach the requisite threshold. Our funds have sought their own tax advice in relation to these proposed new rules and their potential impact on future investments.
The impacts of ATAD II on interest and other finance costs in the context of European investments are jurisdiction specific and will be examined on an investment-by-investment basis.
Further to the BEPS Project, and in particular BEPS Action 1 (“Addressing the Tax Challenges of the Digital Economy”), the OECD published a Report on May 31, 2019 entitled “Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy” (as updated on January 31, 2020 by the “Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy”), which proposes fundamental changes to the international tax system. The proposals (commonly now also referred to as “BEPS 2.0”) are based on two “pillars”, involving the reallocation of taxing rights (Pillar One) and additional global anti-base erosion rules (Pillar Two). On October 12, 2020, the OECD published a report entitled “Tax Challenges Arising from Digitalisation – Economic Impact Assessment”, which among other items, included detailed reports on Pillar One and Pillar Two (in addition to an “Economic Impact Assessment” of the Pillar One and Pillar Two proposals). Although the OECD originally aimed to reach a consensual solution on the new international tax rules during 2020, with a final report by the end of 2020, the OECD’s October 12, 2020 report indicated that a consensus will likely not be reached
until mid-2021. BEPS 2.0 is still in its early stages, and there currently remains uncertainty as to how consensus will be reached and how and when its principles will be implemented by participating countries. Depending on the outcome of BEPS 2.0, effective tax rates could increase within Ares’ structure or on its investments, including by way of higher levels of tax being imposed than is currently the case, possible denial of deductions or increased withholding taxes and/or profits being allocated differently. This could adversely affect the returns of investors in our funds.
The Netherlands continued to provide additional updates to its withholding tax on dividends. Following EU case law, three safe harbor rules currently embedded in domestic anti-abuse rules as part of the Dividend Withholding Tax Act and the Corporate Income Tax Act will no longer function as a safe harbor rule. In addition, the Dutch political party “GroenLinks” has indicated they will issue a legislative proposal to amend the Dividend Withholding Tax Act. Currently, there is no draft bill, nor is it indicated when the draft bill will be presented to parliament. If the bill is accepted, the date of entry into force would be subject to discussion. We are evaluating the impact of this change which could result in additional withholding on certain payments for us and our investment funds.
Certain U.S. holders of sharesstockholders are subject to additional tax on “net investment income.”
U.S. holders of sharesstockholders that are individuals, estates or trusts are subject to a surtax of 3.8% on “net investment income” (or undistributed “net investment income,” in the case of estates and trusts) for each taxable year, with such tax applying to the lesser of such income or the excess of such person’s adjusted gross income (with certain adjustments) over a specified amount. Net investment income includes net incomeearnings from dividends and net gain attributable to the disposition of investment property. It is anticipated that dividends and net gain attributable to an investment in shares of our sharesClass A common stock will be included in a U.S. holder’s “net investment income” subject to this surtax.
Limitations on the amount of interest expense that we may deduct could materially increase our tax liability and negatively affect an investment in shares of our shares.Class A common stock.
For taxable years beginning after December 31, 2017, our deduction of net business interest expenses for each taxable year is limited generally to 30% (or, solely for the taxable years that begin in 2019 or 2020, 50%) of our “adjusted taxable income” for the relevant taxable year (with an election being available for taxable years beginning in 2020 to use adjusted taxable income” from the last taxable year beginning in 2019), which is an amount that is similar to EBITDA for taxable years beginning before January 1, 2022, and similar to earnings before interest and taxes (“EBIT”) for taxable years beginning on or after
January 1, 2022. Any excess business interest not allowed as a deduction in a taxable year as a result of the limitation generally will carry forward to the next year.
There is no grandfather provision for outstanding debt prior to the effective date of these rules. This is a significant change from prior law, which could increase our tax liability.
Any failure to properly manage or address the foregoing risks may have a material adverse effect on our business, results and financial condition.
General Risk Factors
Cybersecurity risks and cyber incidents could adversely affect our business by causing a disruption to our operations, a compromise or corruption of our confidential information and confidential information in our possession and/or damage to our business relationships, any of which could negatively impact our business, financial condition and operating results.
There has been an increase in the frequency and sophistication of the cyber and security threats we face, with attacks ranging from those common to businesses generally to more advanced and persistent attacks. We may be a target because, as an alternative asset management firm, we hold confidential and other price sensitive information about existing and potential investments. We are dependent on third-party vendors for hosting solutions and technologies that we do not control. We also rely on third-party service providers for certain aspects of our businesses, including for certain information systems, technology and administration of our funds and compliance matters. We perform risk assessments on our third-party providers but our reliance on them and their reliance on other third-parties could adversely affect us. Cyber attacks and other security threats could originate from a wide variety of sources, including cyber criminals, nation state hackers, hacktivists and other outside parties. As a result, we may face a heightened risk of a security breach or disruption with respect to sensitive information resulting from an attack by computer hackers, foreign governments or cyber terrorists.
The efficient operation of our business is dependent on computer hardware and software systems, as well as data processing systems and the secure processing, storage and transmission of information, which are vulnerable to security breaches and cyber incidents. A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or an unintentional event and could
involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. In addition, we and our employees may be the target of fraudulent emails or other targeted attempts to gain unauthorized access to proprietary or sensitive information. The result of these incidents may include disrupted operations, misstated or unreliable financial data, fraudulent transfers or requests for transfers of money, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our business relationships, causing our business and results of operations to suffer. As our reliance on technology has increased, so have the risks posed to our information systems, both internal and those provided by third-party service providers. We have implemented processes, procedures and internal controls designed to mitigate cybersecurity risks and cyber intrusions and rely on securities measures and technology to securely maintain confidential and proprietary information maintained on our information systems; however, these measures, as well as our increased awareness of the nature and extent of a risk of a cyber-incident, do not guarantee that a cyber-incident will not occur and/or that our financial results, operations or confidential information will not be negatively impacted by such an incident, especially because the cyber-incident techniques change frequently or are not recognized until launched and because cyber-incidents can originate from a wide variety of sources.
These risks are exacerbated by the rapidly increasing volume of highly sensitive data, including our proprietary business information and intellectual property, and personally identifiable information of our employees, our investors and others, that we collect and store in our data centers and on our networks. The secure processing, maintenance and transmission of this information are critical to our operations. A significant actual or potential theft, loss, corruption, exposure, fraudulent use or misuse of investor, employee or other personally identifiable or proprietary business data, whether by third parties or as a result of employee malfeasance or otherwise, non-compliance with our contractual or other legal obligations regarding such data or intellectual property or a violation of our privacy and security policies with respect to such data could result in significant remediation and other costs, fines, litigation or regulatory actions against us and significant reputational harm.
Our funds’ portfolio companies also rely on similar systems and face similar risks. A disruption or compromise of these systems could have a material adverse effect on the value of these businesses. Our funds may invest in strategic assets having a national or regional profile or in infrastructure assets, the nature of which could expose them to a greater risk of being subject to a terrorist attack or security breach than other assets or businesses. Such an event may have material adverse consequences on our investment or assets of the same type or may require applicable portfolio companies to increase preventative security measures or expand insurance coverage.
In addition, we operate in businesses that are highly dependent on information systems and technology. The costs related to cyber or other security threats or disruptions may not be fully insured or indemnified by other means. Cybersecurity has become a priority for regulators in the U.S. and around the world. Many jurisdictions in which we operate have laws and regulations relating to data privacy, cybersecurity and protection of personal information, including, the California Consumer Privacy Act that went into effect on January 1, 2020, and the New York SHIELD Act, which became effective on March 1, 2020. In addition, the SEC announced that one of the 2019 examination priorities for the Office of Compliance Inspections and Examinations was to continue to examine cybersecurity procedures and controls, including testing the implementation of these procedures and controls. Further, the European General Data Protection Regulation (the “GDPR”) came into effect in May 2018. Data protection requirements under the GDPR are more stringent than those imposed under prior European legislation. There are substantial financial penalties for breach of the GDPR, including up to the higher of 20 million Euros or 4% of group annual worldwide turnover. The U.K. has adopted GDPR and similar requirements therefore continue to apply in the U.K. notwithstanding Brexit (“UK GDPR”). However, as a result of Brexit, the U.K. is now a third country for the purposes of GDPR as it applies in the EU (“EU GDPR”). The TCA provides for a transitional period during which transfers of personal data from the EU to the U.K. will not be considered as transfers to a third country under EU GDPR. If this transitional period ends without the European Commission adopting an adequacy decision in relation to the U.K., transfers of personal data from the EU to the U.K. will be subject to additional requirements under the EU GDPR rules on exporting data outside the EU. Transfers of personal data from the U.K. to the EU will continue to be permitted under UK GDPR without the need for compliance with such additional data export requirements. Non-compliance with any of these laws, as well as others, represents a serious risk to our business. Some jurisdictions have also enacted laws requiring companies to notify individuals of data security breaches involving certain types of personal data. Breaches in security could potentially jeopardize our, our employees’ or our fund investors’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our employees’, our fund investors’, our counterparties’ or third parties’ operations, which could result in significant losses, increased costs, disruption of our business, liability to our fund investors and other counterparties, regulatory intervention or reputational damage. Furthermore, if we fail to comply with the relevant laws and regulations, it could result in regulatory investigations and penalties, which could lead to negative publicity and may cause our fund investors and clients to lose confidence in the effectiveness of our security measures.
Although we are not currently aware of any cyber attacks or other incidents that, individually or in the aggregate, have materially affected, or would reasonably be expected to materially affect, our operations or financial condition, there can be no
assurance that the various procedures and controls we utilize to mitigate these threats will be sufficient to prevent disruptions to our systems, especially because the cyberattack techniques used change frequently and are not recognized until launched, the full scope of a cyberattack may not be realized until an investigation has been performed and cyber attacks can originate from a wide variety of sources. We rely on industry accepted security measures and technology to securely maintain confidential and proprietary information maintained on our information systems. Although we take protective measures and endeavors to strengthen our computer systems, software, technology assets and networks to prevent and address potential cyber attacks, there can be no assurance that any of these measures prove effective. We expect to be required to devote increasing levels of funding and resources to comply with evolving cybersecurity regulations and to continually monitor and enhance our cybersecurity procedures and controls.
We may be subject to litigation risks and may face liabilities and damage to our professional reputation as a result.
In recent years, the volume of claims and amount of damages claimed in litigation and regulatory proceedings against investment managers have been increasing. We make investment decisions on behalf of investors in our funds that could result in substantial losses. This may subject us to the risk of legal liabilities or actions alleging negligent misconduct, breach of fiduciary duty or breach of contract. Further, we may be subject to third-party litigation arising from allegations that we improperly exercised control or influence over portfolio investments. In addition, we and our affiliates that are the investment managers and general partners of our funds, our funds themselves and those of our employees who are our, our subsidiaries’ or the funds’ officers and directors are each exposed to the risks of litigation specific to the funds’ investment activities and portfolio companies and, in the case where our funds own controlling interests in public companies, to the risk of shareholder litigation by the public companies’ other shareholders. Moreover, we are exposed to risks of litigation or investigation by investors or regulators relating to our having engaged, or our funds having engaged, in transactions that presented conflicts of interest that were not properly addressed.
Legal liability could have a material adverse effect on our businesses, financial condition or results of operations or cause reputational harm to us, which could harm our businesses. We depend to a large extent on our business relationships and our reputation for integrity and high-caliber professional services to attract and retain investors and to pursue investment opportunities for our funds. As a result, allegations of improper conduct asserted by private litigants or regulators, regardless of whether the ultimate outcome is favorable or unfavorable to us, as well as negative publicity and press speculation about us, our investment activities or the investment industry in general, whether or not valid, may harm our reputation, which may be damaging to our businesses.
In addition, the laws and regulations governing the limited liability of such issuers and portfolio companies vary from jurisdiction to jurisdiction, and in certain contexts the laws of certain jurisdictions may provide not only for carve-outs from limited liability protection for the issuer or portfolio company that has incurred the liabilities, but also for recourse to assets of other entities under common control with, or that are part of the same economic group as, such issuer. For example, if one of our portfolio companies is subject to bankruptcy or insolvency proceedings in a jurisdiction and is found to have liabilities under the local consumer protection, labor, tax or bankruptcy laws, the laws of that jurisdiction may permit authorities or creditors to file a lien on, or to otherwise have recourse to, assets held by other portfolio companies (including assets held by us) in that jurisdiction. There can be no assurance that we will not be adversely affected as a result of the foregoing risks.
In addition, we may not be able to obtain or maintain sufficient insurance on commercially reasonable terms or with adequate coverage levels against potential liabilities we may face in connection with potential claims, which could have a material adverse effect on our business. We may face a risk of loss from a variety of claims, including related to securities, antitrust, contracts, cybersecurity, fraud and various other potential claims, whether or not such claims are valid. Insurance and other safeguards might only partially reimburse us for our losses, if at all, and if a claim is successful and exceeds or is not covered by our insurance policies, we may be required to pay a substantial amount in respect of such successful claim. Certain losses of a catastrophic nature, such as losses arising as a result of wars, earthquakes, typhoons, terrorist attacks or other similar events, may be uninsurable or may only be insurable at rates that are so high that maintaining coverage would cause an adverse impact on our business, our investment funds and their portfolio companies. In general, losses related to terrorism are becoming harder and more expensive to insure against. Some insurers are excluding terrorism coverage from their all-risk policies. In some cases, insurers are offering significantly limited coverage against terrorist acts for additional premiums, which can greatly increase the total cost of casualty insurance for a property. As a result, we, our investment funds and their portfolio companies may not be insured against terrorism or certain other catastrophic losses.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our principal executive offices are located in leased office space at 2000 Avenue of the Stars, 12th Floor, Los Angeles, California. We also lease office space in Culver City, Atlanta, Chicago, Dallas, New York, City, Washington, D.C., St. Louis, Dubai, Frankfurt, London Luxembourg, Paris, Stockholm, Chengdu, Hong Kong, Shanghai, Sydney, Sausalito, Needham, Tarrytown, and Williamsville.other cities around the world. We do not own any real property. We consider these facilities to be suitable and adequate for the management and operation of our businesses.
Item 3. Legal Proceedings
From time to time we are involved in various legal proceedings, lawsuits and claims incidental to the conduct of our business, some of which may be material. As of December 31, 2020 and 2019, we were not subject to any material pending legal proceedings. Our businesses are also subject to extensive regulation, which may result in regulatory proceedings against us.
Item 4. Mine Safety Disclosures
None.Not applicable.
PART II.
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters And Issuer Purchases Of Equity Securities
Market Information
Our Class A common shares representing limited partner interests in Ares Management, L.P. arestock is traded on the NYSE under the symbol “ARES.”“ARES". Our common shares began trading on the NYSE on May 2, 2014. AsWe completed our Conversion from a result of changing the name of ourDelaware limited partnership to a Delaware corporation effective on November 26, 2018. Our Class A common units and preferred unitsstock continued to common shares and preferred shares, respectively, effective March 2, 2018 our common shares and preferred shares will officially trade with such revised names on the NYSE under our existing symbols.
Thesymbol following table sets forth the high and low intra‑day sales prices per share of our common shares, for the periods indicated, as reported by the NYSE.
|
| | | | | | | | | | | | | | | |
| | Sales Price |
| | 2017 | | 2016 |
| | High | | Low | | High | | Low |
| First Quarter | $ | 23.25 |
| | $ | 17.15 |
| | $ | 15.50 |
| | $ | 10.76 |
|
| Second Quarter | $ | 19.80 |
| | $ | 17.25 |
| | $ | 15.96 |
| | $ | 12.08 |
|
| Third Quarter | $ | 18.85 |
| | $ | 17.40 |
| | $ | 19.54 |
| | $ | 13.81 |
|
| Fourth Quarter | $ | 20.00 |
| | $ | 18.00 |
| | $ | 19.20 |
| | $ | 14.75 |
|
Conversion.
The number of holders of record of our Class A common sharesstock as of February 18, 2021 was 15, 2018 was 2. Thiswhich does not include the number of sharesholdersshareholders that hold shares in “street name” through banks or broker-dealers. Ares Management GP LLC is the sole holder of shares of our Class B Common Stock and Ares Voting LLC is the sole holder of shares of our Class C Common Stock.
Stock Performance Graph
The following graph depicts the total return to holders of our Class A common stock from the closing price on December 31, 2015 through December 31, 2020, relative to the performance of the S&P 500 Index and the Dow Jones U.S. Asset Managers Index. The graph assumes $100 invested on December 31, 2015 and dividends received reinvested in the security or index.
The performance graph is not intended to be indicative of future performance. The performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any of the Company’s filings under the Securities Act or the Exchange Act.
Total Return Performance Table
Issuer Purchases of Equity Securities
The table below presents purchases made by or on behalf of Ares Management L.P.Corporation or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of shares of our common sharesClass A Common Stock during each of the indicated periods.
periods ($ in thousands; except share data): |
| | | | | | | | | | | | | |
| Period | | Total Number of Common Shares Purchased(1)Purchased | | Average Price Paid Per Common SharesShare | | Total Number of Common Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum NumberApproximate Dollar Value of Common Shares That May Yet Bebe Purchased Under the PlanPlans or ProgramPrograms (1) |
October 1, to2020 - October 31, 20172020 | — | —$ |
— | | $— | —$ |
150,000 | | — |
| | — |
|
November 1, to2020 - November 30, 20172020 | — | — |
| — | $150,000 | — |
| | — |
| | — |
|
December 1, to2020 - December 31, 20172020 | — | — |
| — | $150,000 | — |
| Total |
— | | — |
| | — |
|
On March 2, 2017, AREC Holdings Ltd., a wholly owned subsidiary(1)In February 2020, our board of Abu Dhabi Investment Authority (“ADIA” or “the selling shareholder”) sold 7,500,000directors approved the renewal of our stock repurchase program that authorizes the repurchase of up to $150 million of shares of the Company’sour Class A common stock. Under this stock repurchase program, shares through a public secondary offering. The Company did not receive anymay be repurchased from time to time in open market purchases, privately negotiated transactions or otherwise, including in reliance on Rule 10b5-1 of the proceeds fromSecurities Act. In February 2021, our board of directors approved the offering. The Company incurred approximately $0.7 millionrenewal of expenses relatedthe program and it is scheduled to expire in February 2022. Repurchases under the secondary offering transaction. The fees related toprogram depend on the secondary offering were non-operating expensesprevailing market conditions and are included in other income, net in the Consolidated Statements of Operations. The selling shareholder paid the underwriting discounts and commissions and/or similar charges incurredfactors.
Dividend Policy for the sale of the common shares.Series A Preferred Stock
Distribution Policy for Preferred Equity
As of December 31, 20172020 and 2016,2019, the Company had 12,400,000 shares of Series A Preferred Equity (the “Preferred Equity”)Stock outstanding. When, as and if declared by the Company’s board of directors, distributionsdividends on the Series A Preferred EquityStock are paid quarterly at a rate per annum equal to 7.00%. During 20172020 and 2016,2019, we paid quarterly distributions ofdividends totaling approximately $21.7 million and $12.2 million, respectively, to our preferred equity holders of record, and in February 2018, the board of directors of
our general partner declared quarterly distribution of $5.4 million in respect of the fourth quarter of 2017 payable on March 31, 2018 each year to holders of record of preferred equityshares of the Series A Preferred Stockholders, and in February 2021, the Company's board of directors declared a quarterly dividend of $5.4 million payable on March 31, 2021 to holders of record of shares of the Series A Preferred Stock at the close of business on March 15, 2018.2021.
Dividend Policy for Class A Common Shares PriorStock
During 2019, we declared a dividend each quarter of $0.32 (totaling $1.28 annually) per share to Effectiveness of Tax Election
During 2016, we paid quarterly distributions of $0.20, $0.28, $0.15 and $0.20 perClass A common share (totaling $0.83 per common share) to record holders of common shares,stockholders, or approximately $67.0$138.6 million. During 2017,2020, we paid quarterly distributions of $0.28, $0.13, $0.31 and $0.41 per common share (totaling $1.13 per common share) to record holders of common shares, or approximately $92.6 million, and in February 2018, the board of directors of our general partner declared an additional distribution of $0.40 per common share, or approximately $33.1 million, inclusive of $0.25 per common share for the fourth of 2017 and $0.15 per common share for the first two months of the firsta dividend each quarter of 2018, payable on February 28, 2018$0.40 (totaling $1.60 annually) per share to Class A common shareholders of recordstockholders at the close of business on March 17, 2020, June 16, 2020, September 16, 2020, and December 17, 2020, respectively, or approximately $217.7 million.
In February 26, 2018.
We distributed to our common shareholders on2021, the Company's board of directors declared a quarterly basis substantially alldividend of Ares Management, L.P.’s $0.47 per share of distributable earnings, netClass A common stock, or approximately $70.3 million, with respect to the first quarter of any applicable corporate taxes and amounts2021 payable underon March 31, 2021 to common stockholders of record at the tax receivable agreement, in excessclose of amounts determined bybusiness on March 17, 2021.
Our dividend policy for our general partner to be necessary or appropriate to provide for the conduct of our businesses, to make appropriate investments in our businesses and our funds, to comply with applicable law, any of our debt instruments and preferred shares or other agreements or to provide for future distributions to ourClass A common shareholders for any ensuing quarter, subject to a base quarterly distribution target range of 80% to 90% of distributable earnings. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Segment Analysis-Reconciliation of Certain Non‑GAAP Measures to Consolidated GAAP Financial Measures” for a reconciliation of our distributable earnings to our income before taxes presented in accordance with GAAP.
In most years, the aggregate amounts of distributions to our preferred and common shareholders did not equal our distributable earnings for that year. Our distributable earnings were only a starting point for the determination of the amount to be distributed to our common shareholders because, as noted above, in determining the amount to be distributed, we subtracted from our distributable earnings any amounts determined by our general partner to be necessary or appropriate to provide for the conduct of our businesses, to make appropriate investments in our businesses and our funds, to comply with applicable law, any of our debt instruments or other agreements or to provide for future distributions to our preferred and common shareholders for any ensuing quarter.
Distribution Policy for Common Shares Following Effectiveness of Tax Election
In conjunction with the Tax Election, we have adopted a distribution policy that will reduce volatility of the quarterly distributions and becomestock is more closely aligned with our core management fee business. We intend to provide a steady quarterly dividend for each calendar year that will be based on our expected after-tax fee related earnings, with future potential changes based on the level and growth of our after-tax fee related earnings. For March 2018,Subject to the first month that we are taxed as a corporation, we declared a distributionapproval of $0.0933 per common share, reflecting one-thirdour board of a full quarter $0.28 per share distribution. Starting in the second quarter of 2018,directors, we intend to pay a $0.28dividend of $0.47 per share of our Class A common share distributionstock per quarter for the remainder of 2018. For distributions made following the effective date of March 1, 2018, investors will now receive income reported on a Form 1099-DIV instead of a Schedule K-1.in 2021.
Our fixed distributiondividend will be reassessed each year based upon the level and growth of our after-tax fee related earnings. As fee related earnings reflect the core earnings of our business and consists of management fees less compensation and general and administrative expenses, having our recurring distributiondividend based on this amount removes volatility from our distributiondividend and enables investors to receive what we believe is an attractive after-tax, qualifying distributiondividend yield.
As we have historically distributed to our common shareholders substantially all of our distributable earnings, we have not retained earnings for future growth.Our new distributiondividend policy reflects our intention to retain net performance fees.income. We expect to use such retained earnings for potential sharestock repurchases and to fund future growth with the objective of accelerating our fee related earnings growth per share. However, the declaration, payment and determination of the amount of future distributions,dividends, if any, is at the sole discretion of theour board of directors of our general partner, which may change our distributiondividend policy at any time.
Under the Delaware Limited Partnership Act, Ares Management, L.P. may not make a distribution to a partner if after the distribution, allThe payment of cash dividends on shares of our liabilities, other than liabilitiesClass A common stock is subject to partners on account of their partnership interests and liabilities for which the recourse of creditors is limited to specific property of the partnership, would exceed the fair value of our assets. If we were to make such an impermissible distribution, any limited partner who received a distribution and knew at the time of the distribution that the distribution was in violation of the Delaware Limited Partnership Act would be liable to us for the amount of
the distribution for three years from the date of such distribution.compliance with DGCL. In addition, under the Credit Facility, certain subsidiaries of the Ares Operating Group are prohibited from making distributionspaying dividends in certain circumstances, including if an Event of Default (as defined in the Credit Facility) has occurred and is continuing.
Because Ares Management L.P.Corporation is a holding company and has no material assets other than its indirect ownership of Ares Operating Group Units, we fund distributionsdividends by Ares Management L.P.Corporation on theshares of our Class A common shares,stock, if any, in three steps:
•first, we cause the Ares Operating Group entities to make distributions to their partners, including Ares Management L.P.Corporation and its direct subsidiaries. If the Ares Operating Group entities make such distributions, the partners of the Ares Operating Group entities will be entitled to receive equivalent distributions pro rata based on their partnership units in the Ares Operating Group (except as set forth in the following paragraph);
•second, we cause Ares Management L.P.’sCorporation’s direct subsidiaries to distribute to Ares Management L.P.Corporation their share of such distributions, net of any taxes and amounts payable under the tax receivable agreement by such direct subsidiaries; and
•third, Ares Management L.P. distributesCorporation pays such distributions to our holders of our Class A common equityholders,stock, net of any taxes and amounts payable under the tax receivable agreement, on a pro rata basis.
Because we and our direct subsidiaries that are corporations for U.S. federal income tax purposes may be required to pay corporate income and franchise taxes and make payments under the tax receivable agreement, the dividend amounts ultimately distributedpaid by us to holders of our Class A common shareholdersstock are expected to be generally less, on a per share basis, than the amounts distributed by the Ares Operating Group entities to their respective partners in respect of their Ares Operating Group Units.
In addition, governing agreements of the Ares Operating Group entities provide for cash distributions, which we refer to as “tax distributions,” to the partners of such entities if the general partners of the Ares Operating Group entities determine that the taxable income of the relevant Ares Operating Group entity gives rise to taxable income for its partners. Generally, these tax distributions are computed based on our estimate of the net taxable income of the relevant entity multiplied by an assumed tax rate equal to the highest effective marginal combined U.S. federal, state and local income tax rate prescribed for an
individual or corporate resident in Los Angeles, California or New York, New York, whichever is higher (taking into account the non‑deductibilitynon-deductibility of certain expenses and the character of our income). The Ares Operating Group makes tax distributions only if and to the extent distributions from such entities for the relevant year were otherwise insufficient to cover such tax liabilities.
In addition, the cash flow from operations of the Ares Operating Group entities may be insufficient to enable them to make required minimum tax distributions to their partners, in which case the Ares Operating Group may have to borrow funds or sell assets, which could have a material adverse effect on our liquidity and financial condition. Furthermore, by paying cash distributionsdividends rather than investing that cash in our businesses, we might risk slowing the pace of our growth, or not having a sufficient amount of cash to fund our operations, new investments or unanticipated capital expenditures, should the need arise.
Although a portion of any distributionsdividends paid by us to holders of our Class A common shareholdersstock may include carried interest received by us, we do not intend to seek fulfillment of any contingent repayment obligation by seeking to have holders of our Class A common shareholdersstock return any portion of such distributionsdividends attributable to carried interest associated with any contingent repayment obligation.
We expect any distributions madedividends paid out of current or accumulated earnings and profits to U.S. individuals and certain other qualifying shareholdersholders of our Class A common stock to constitute “qualified dividend” income that is generally taxed at a more favorable lower tax rate than the ordinary income tax rate, if the requisite holding periods have been met. If the distributiondividend exceeds current and accumulated earnings and profits, the excess is treated as a nontaxable return of capital, reducing the shareholder’sstockholder’s tax basis in its shares to the extent of such shareholder’s tax basis in such shares. Any remaining excess is treated as capital gain. Because entities treated asU.S. corporations for U.S. federal income tax purposes are taxed on their own taxable income, and because owners of such entities are taxed on any dividends distributedpaid from such entities, there are two levels of potential tax upon income earned by such entities.
Unregistered Sales of Equity Securities and Purchases of Equity Securities
None.
Item 6. Selected Financial Data
The following tables present selected consolidated financial information and other data of the Company and its Predecessor. The Company was formed on November 15, 2013 to serve as a holding partnership for our businesses. See “Item 1. Business—Organizational Structure.”
We derived the following selected consolidatedConsolidated financial data of the Company as of December 31, 2020 and 2019 and for the years ended December 31, 2020, 2019, and 2018 can be derived from the audited consolidated financial statements included in this Annual Report on Form 10-K. Consolidated financial data of the Company as of December 31, 2018, 2017 and 2016 and for the years ended December 31, 2017 and 2016 and 2015can be derived from the audited consolidated financial statements included elsewherePart II, “Item 6. Selected Financial Data” in thisour Annual Report on Form 10‑K. The selected consolidated financial data of the Company as of and for the year ended 2014 was derived from the audited consolidated financial statements of the Company, which are not included in this Annual Report on Form 10-K. The selected consolidated financial data as of and10-K for the year ended December 31, 2013 was derived from2019. Management believes that no material trends have been omitted by removing the audited consolidated financial statementstabular disclosure.
For the period ended December 31, 2013, non-controlling interests in Ares Operating Group entities represent equity interests and net income attributable to various minority non-control oriented strategic investment partners, including the Predecessor’s historical results. The net income attributable to controlling interests in the Predecessor, from January 1, 2014 to April 30, 2014, is presented together with net income attributable to non-controlling interests in Ares Operating Group entities within the Consolidated Statements of Operations.
The entities comprising our Consolidated Funds are not the same entities for all periods presented primarily due to the adoption of new consolidation guidance. Pursuant to revised consolidation guidance that became effective for us on January 1, 2015, we consolidated entities where we hold a controlling financial interest. The consolidation of funds during the periods generally has the effect of grossing up reported assets, liabilities and cash flow, and has no effect on net income attributable to the Company and the Predecessor. See “ItemItem 7. Management’s Discussion and Analysis of of Financial Condition and Results of Operations—Consolidation and Deconsolidation of Ares Funds” and “—Critical Accounting Estimates—Principles of Consolidation” and Note 2, “Summary of Significant Accounting Policies,” to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K.
The following selected historical consolidated financial data should be read together with “Item 1. Business—Organizational Structure,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”and our historical consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10‑K.
|
| | | | | | | | | | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | |
| | | | | | | | | | (Predecessor) | |
| | (Dollars in thousands) |
| Statements of operations data | | | | | | | | | | |
| Revenues | | | | | | | | | | |
| Management fees (includes ARCC Part I Fees of $105,467, $121,181, $121,491, $118,537 and $110,511 for the years ended December 31, 2017, 2016, 2015, 2014 and 2013, respectively) | $ | 722,419 |
| | $ | 642,068 |
| | $ | 634,399 |
| | $ | 486,477 |
| | $ | 375,572 |
| |
| Performance fees | 636,674 |
| | 517,852 |
| | 150,615 |
| | 91,412 |
| | 79,800 |
| |
| Administrative, transaction and other fees | 56,406 |
| | 39,285 |
| | 29,428 |
| | 26,000 |
| | 23,283 |
| |
| Total revenues | 1,415,499 |
| | 1,199,205 |
| | 814,442 |
| | 603,889 |
| | 478,655 |
| |
| Expenses | | | | | | | | | | |
| Compensation and benefits | 514,109 |
| | 447,725 |
| | 414,454 |
| | 456,372 |
| | 333,902 |
| |
| Performance fee compensation | 479,722 |
| | 387,846 |
| | 111,683 |
| | 170,028 |
| | 194,294 |
| |
| General, administrative and other expenses | 196,730 |
| | 159,776 |
| | 224,798 |
| | 166,839 |
| | 138,464 |
| |
| Transaction support expense | 275,177 |
| | — |
| | — |
| | — |
| | — |
| |
| Expenses of Consolidated Funds | 39,020 |
| | 21,073 |
| | 18,105 |
| | 66,800 |
| | 135,237 |
| |
| Total expenses | 1,504,758 |
| | 1,016,420 |
| | 769,040 |
| | 860,039 |
| | 801,897 |
| |
| Other income (expense) | | | | | | | | | | |
| Net realized and unrealized gain on investments | 67,034 |
| | 28,251 |
| | 17,009 |
| | 32,128 |
| | 8,922 |
| |
| Interest and dividend income | 12,715 |
| | 23,781 |
| | 14,045 |
| | 7,244 |
| | 5,996 |
| |
| Interest expense | (21,219 | ) | | (17,981 | ) | | (18,949 | ) | | (8,617 | ) | | (9,475 | ) | |
| Debt extinguishment expense | — |
| | — |
| | (11,641 | ) | | — |
| | (1,862 | ) | |
| Other income (expense), net | 19,470 |
| | 35,650 |
| | 21,680 |
| | (2,422 | ) | | (200 | ) | |
| Net realized and unrealized gain (loss) on investments of Consolidated Funds | 100,124 |
| | (2,057 | ) | | (24,616 | ) | | 513,270 |
| | 479,096 |
| |
| Interest and other income of Consolidated Funds | 187,721 |
| | 138,943 |
| | 117,373 |
| | 937,835 |
| | 1,236,037 |
| |
| Interest expense of Consolidated Funds | (126,727 | ) | | (91,452 | ) | | (78,819 | ) | | (666,373 | ) | | (534,431 | ) | |
| Debt extinguishment gain of Consolidated Funds | — |
| | — |
| | — |
| | — |
| | 11,800 |
| |
| Total other income | 239,118 |
| | 115,135 |
| | 36,082 |
| | 813,065 |
| | 1,195,883 |
| |
| Income before taxes | 149,859 |
| | 297,920 |
|
| 81,484 |
|
| 556,915 |
|
| 872,641 |
|
|
| Income tax expense (benefit) | (23,052 | ) | | 11,019 |
| | 19,064 |
| | 11,253 |
| | 59,263 |
| |
| Net income | 172,911 |
| | 286,901 |
|
| 62,420 |
|
| 545,662 |
|
| 813,378 |
|
|
| Less: Net income attributable to redeemable interests in Consolidated Funds | — |
| | — |
| | — |
| | 2,565 |
| | 137,924 |
| |
| Less: Net income (loss) attributable to non-controlling interests in Consolidated Funds | 60,818 |
| | 3,386 |
| | (5,686 | ) | | 417,793 |
| | 448,847 |
| |
| Less: Net income attributable to redeemable interests in Ares Operating Group entities | — |
| | 456 |
| | 338 |
| | 731 |
| | 2,451 |
| |
| Less: Net income attributable to non-controlling interests in Ares Operating Group entities | 35,915 |
| | 171,251 |
| | 48,390 |
| | 89,585 |
| | 224,156 |
| |
| Net income attributable to Ares Management, L.P. | 76,178 |
| | 111,808 |
|
| 19,378 |
|
| 34,988 |
|
| — |
|
|
| Less: Preferred equity distributions paid | 21,700 |
| | 12,176 |
| | — |
| | — |
| | — |
| |
| Net income attributable to Ares Management, L.P. common unitholders | $ | 54,478 |
| | $ | 99,632 |
|
| $ | 19,378 |
|
| $ | 34,988 |
|
| $ | — |
|
|
|
| | | | | | | | | | | | | | | | | | | | |
| | As of December 31, |
| | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | |
| | | | | | | | | | (Predecessor) | |
| | (Dollars in thousands) |
| Statements of financial condition data | | | | | | | | | | |
| Cash and cash equivalents | $ | 118,929 |
| | $ | 342,861 |
| | $ | 121,483 |
| | $ | 148,858 |
| | $ | 89,802 |
| |
| Cash and cash equivalents of Consolidated Funds | 556,500 |
| | 455,280 |
| | 159,507 |
| | 1,314,397 |
| | 1,638,003 |
| |
| Investments | 647,335 |
| | 468,471 |
| | 468,287 |
| | 174,052 |
| | 89,438 |
| |
| Investments, at fair value, of Consolidated Funds | 5,582,842 |
| | 3,330,203 |
| | 2,559,783 |
| | 19,123,950 |
| | 20,823,338 |
| |
| Total assets | 8,563,522 |
| | 5,829,712 |
| | 4,321,408 |
| | 21,638,992 |
| | 23,705,384 |
| |
| Debt obligations | 616,176 |
| | 305,784 |
| | 389,120 |
| | 243,491 |
| | 153,119 |
| |
| CLO loan obligations of Consolidated Funds | 4,963,194 |
| | 3,031,112 |
| | 2,174,352 |
| | 12,049,170 |
| | 11,774,157 |
| |
| Consolidated Funds’ borrowings | 138,198 |
| | 55,070 |
| | 11,734 |
| | 777,600 |
| | 2,070,598 |
| |
| Mezzanine debt of Consolidated Funds | — |
| | — |
| | — |
| | 378,365 |
| | 323,164 |
| |
| Total liabilities | 7,103,230 |
| | 4,452,450 |
| | 3,329,497 |
| | 14,879,619 |
| | 16,030,319 |
| |
| Redeemable interest in Consolidated Funds | — |
| | — |
| | — |
| | 1,037,450 |
| | 1,093,770 |
| |
| Redeemable interest in Ares Operating Group entities | — |
| | — |
| | 23,505 |
| | 23,988 |
| | 40,751 |
| |
| Non‑controlling interest in Consolidated Funds | 528,488 |
| | 338,035 |
| | 323,606 |
| | 4,950,803 |
| | 5,847,135 |
| |
| Non‑controlling interest in Ares Operating Group entities | 358,186 |
| | 447,615 |
| | 397,883 |
| | 463,493 |
| | 167,731 |
| |
| Total controlling interest in Ares Management, L.P. | 274,857 |
| | 292,851 |
| | 246,917 |
| | 283,639 |
| | 525,678 |
| |
| Total equity | 1,460,292 |
| | 1,377,262 |
| | 968,406 |
| | 5,697,935 |
| | 6,540,544 |
| |
| Total liabilities, redeemable interest, non‑controlling interests and equity | 8,563,522 |
| | 5,829,712 |
| | 4,321,408 |
| | 21,638,992 |
| | 23,705,384 |
| |
Item 7. Management’s Discussion And AnalysisOf Financial Condition And Results Of Operations
Ares Management L.P.Corporation is a Delaware limited partnership formed on November 15, 2013.corporation. Unless the context otherwise requires, references to “Ares,” “we,” “us,” “our,” “the Partnership” and “the Company”the “Company” are intended to mean the business and operations of Ares Management L.P.Corporation and its consolidated subsidiaries. The following discussion analyzes the financial condition and results of operations of the Partnership .Company. “Consolidated Funds” refers collectively to certain Ares‑affiliatedAres funds, related co‑ investmentco-investment entities and certain CLOs that are required under generally accepted accounting principles in the United States (“GAAP”) to be consolidated in our consolidated financial statements included in this Annual Report on Form 10‑K.10-K. Additional terms used by the Company are defined in the Glossary and throughout the Management's Discussion and Analysis in this Annual Report on Form 10-K.
The following discussion and analysis should be read in conjunction with the audited consolidated financial statements of Ares Management L.P.Corporation and the related notes included in this Annual Report on Form 10‑K.10-K.
This section of the Annual Report on Form 10-K discusses activity as of and for the years ended December 31, 2020 and 2019. For discussion on activity for the year ended December 31, 2018 and period-over-period analysis on results for the year ended December 31, 2019 to 2018, refer to Part II, “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in ourAnnual Report on Form 10-K for the year ended December 31, 2019. Amounts and percentages presented throughout our discussion and analysis of financial condition and results of operations may reflect rounded results in thousands (unless otherwise indicated) and consequently, totals may not appear to sum.
Our Business
We are a leading global alternative asset manager that operates through three distinct but complementary investment groups, which are our reportable segments. In 2017, we reclassified certain expenses from OMG to our operating segments. We have presented our reportable segments for the years ended December 31, 2016 and 2015 to conform to the year ended December 31, 2017 presentation.
Our three operating segments are:
Credit Group: Our Credit Group is a leading manager of credit strategies across the non-investment grade credit universe in the U.S. and Europe, with approximately $71.7 billion of assets under management and 139 funds as of December 31, 2017. The Credit Group offers a range of credit strategies across the liquid and illiquid spectrum, including syndicated loans, high yield bonds, credit opportunities, structured credit investments and U.S. and European direct lending. The Credit Group provides solutions for traditional fixed income investors seeking to access the syndicated loans and high yield bond markets and capitalizes on opportunities across traded corporate credit. It additionally provides investors access to directly originated fixed- and floating-rate credit assets and the ability to capitalize on illiquidity premiums across the credit spectrum. The Credit Group’s syndicated loans strategy focuses on liquid, traded non-investment grade secured loans to corporate borrowers. The high yield bond strategy seeks to deliver a diversified portfolio of liquid, traded non-investment grade corporate bonds, including secured, unsecured and subordinated debt instruments. Credit opportunities is a “go anywhere” strategy seeking to capitalize on market inefficiencies and relative value opportunities across the capital structure. The structured credit strategy invests across the capital structures of syndicated collateralized loan obligation vehicles (CLOs) and in directly-originated asset-backed instruments comprised of diversified portfolios of consumer and commercial assets. We are one of the largest self-originating direct lenders to the U.S. and European middle markets, providing one-stop financing solutions for small-to-medium sized companies, which the Company believes are increasingly underserved by traditional lenders. We provide investors access to these capabilities through several vehicles, including commingled funds, separately managed accounts and a publicly traded vehicle. The Credit Group conducts its U.S. corporate lending activities primarily through ARCC, the largest business development company as of December 31, 2017, by both market capitalization and total assets. In addition, the Credit Group manages a commercial finance business that provides asset-based and cash flow loans to small and middle-market companies, as well as asset-based facilities to specialty finance companies. The Credit Group’s European direct lending platform is one of the most significant participants in the European middle-market, focusing on self-originated investments in illiquid middle-market credits.
Private Equity Group: Our Private Equity Group has approximately $24.5 billion of assets under management as of December 31, 2017, broadly categorizing its investment strategies as corporate private equity, U.S. power and energy infrastructure and special situations. As of December 31, 2017, the group managed five corporate private equity commingled funds focused on North America and Europe and two focused on greater China, five commingled funds and six related co-investment vehicles focused on U.S. power and energy infrastructure and three special situations funds. In its North American and European flexible capital strategy, the Company targets opportunistic majority or shared-control investments in businesses with strong franchises and attractive growth opportunities in North America and Europe. The U.S. power and energy infrastructure strategy targets U.S. energy infrastructure-related assets across the power generation, transmission and midstream sectors, seeking attractive risk-adjusted equity returns with current cash flow and capital
appreciation. The special situations strategy seeks to invest opportunistically across a broad spectrum of distressed or mispriced investments, including corporate debt, rescue capital, private asset-backed investments, post-reorganization securities and non-performing portfolios.
Real Estate Group: Our Real Estate Group manages comprehensive public and private equity and debt strategies, with approximately $10.2 billion of assets under management across 42 funds as of December 31, 2017. Real Estate equity strategies focus on applying hands-on value creation initiatives to mismanaged and capital-starved assets, as well as new development, ultimately selling stabilized assets back into the market. The Real Estate Group manages both a value-add strategy and an opportunistic strategy. The value-add strategy seeks to create value by buying assets at attractive valuations and through active asset management of income-producing properties across the U.S. and Western Europe. The opportunistic strategy focuses on manufacturing core assets through development, redevelopment and fixing distressed capital structures across major property types in the U.S. and Europe. The Company’s debt strategies leverage the Real Estate Group’s diverse sources of capital to directly originate and manage commercial mortgage investments on properties that range from stabilized to requiring hands-on value creation. In addition to managing private debt funds, the Real Estate Group makes debt investments through a publicly traded commercial mortgage REIT, ACRE.
The Operations Management Group (“OMG”) consists of five shared resource groups to support our operating segments by providing infrastructure and administrative support in the areas of accounting/finance, operations/information technology, business development/corporate strategy, legal/compliance and human resources. Additionally, the OMG provides services to certain of our investment companies and partnerships, which reimburse the OMG for expenses equal to the cost of services provided. The OMG’s expenses are not allocated to our three reportable segments but we consider the cost structure of the OMG when evaluating our financial performance.
The focus of our business model is to provide our investment management capabilities through various funds and products that meet the needs of a wide range of institutional and retail investors. Our revenues consist primarily of management fees and performance fees, as well as investment income and administrative expense reimbursements. Management fees are generally based on a defined percentage of average fair value of assets, total commitments, invested capital, net asset value, net investment income or par value of the investment portfolios we manage. Performance fees are based on certain specific hurdle rates as defined in the funds' applicable investment management or partnership agreements and represent either an incentive fee or carried interest. Other income (expense) represents the investment income, realized gains (losses) and unrealized appreciation (depreciation) resulting from the investments of the Company and the Consolidated Funds, as well as interest expense. We provide administrative services to certain of our affiliated funds that are presented within administrative, transaction and other fees for GAAP reporting, but are presented net of respective expenses for segment reporting purposes. We also receive transaction fees from certain affiliated funds for activities related to fund transactions, such as loan originations. In accordance with GAAP, we are required to consolidate those funds in which we hold a significant economic interest and substantive control rights. However, for segment reporting purposes, we present revenues and expenses on a combined segment basis, which shows the results of our reportable segments without giving effect to the consolidation of the funds. Accordingly, our segment revenues consist of management fees, other income, realized and unrealized performance fees, and net investment income. Our segment expenses consist of compensation and benefits, net of administrative fees, general, administrative and other expenses, net of administrative fees, as well as realized and unrealized performance fee compensation.
Trends Affecting Our Business
We believe that our disciplined investment philosophy across our three distinct but complementary investment groups contributes to the stability of our firm’s performance throughout market cycles. Additionally, asAs of December 31, 2020, approximately 72%67% of our assets under managementAUM were in funds with a remaining contractual life of three years or more, and approximately 42%74% of our AUM were in funds with a contractual life ofan initial duration greater than seven years or more asat time of December 31, 2017,closing and 90% of our management fees were derived from permanent capital vehicles, CLOs and closed end funds. Our funds have a stable base of committed capital enabling us to invest in assets with a long termlong-term focus over different points in a market cycle and to take advantage of market volatility. However, our results of operations, including the fair value of our AUM, are affected by a variety of factors, particularly in the United States and Western Europe, including conditions in the global financial markets and the economic and political environments, particularlyenvironments.
Global capital markets performance was dominated by the onset of the COVID-19 pandemic and the associated uncertainty and significant market declines in the United States and Western Europe.
December 2017 markedfirst half of 2020. The markets experienced a modestly positive end torebound in the year for credit markets as improving economic conditions, rising corporate earnings,second half of 2020, primarily driven by additional fiscal stimulus, accommodative global monetary policy and falling inflation expectations supported investor sentiment. Despite sector specific gains experiencedpositive vaccine developments to combat COVID-19.Investor concerns over rising infection rates and newly implemented lockdown measures subsided relative to optimism in November,connection with the announced approval and initial distribution of vaccines in the U.S. and more broadly. In the U.S., corporate credit spreads generally continued to tighten throughoutnarrowed into year-end and lower quality paper, along with more cyclical segments, drove returns for the fourth quarter of 2017. In response to compressing yields, investors generally sought higher yielding risk assets globally. Similar to 2016, market participants were rewarded for a “risk-on” posture and as a result, the ICE BofAML High Yield Master II Index returned 7.48% for 2017, primarily driven by the CCC portion of the index which returned 10.59% during the year. The leveraged loan market experienced similar return patterns withquarter. Specifically, the Credit Suisse Leveraged Loan Index delivering(“CSLLI”), a 4.25% totalleveraged loan index, returned 2.8% for 2020 compared to a return of 8.2% for the full year, led byprior year. The ICE BAML High Yield Master II Index, a 7.45%high yield bond index, returned 6.2% for 2020 compared to a return of 14.4% for the lower tier segment of the market. Against a backdrop of improving macroeconomic and corporate fundamentals asprior year.
well as enthusiasm over tax reform in the U.S., equities (measured by the S&P 500 Index) continued to reach record highs throughout the year and outperformed most asset classes with a year-to-date return of 21.83%.
European credit markets continuedexperienced similar results, as European high yield and leveraged loan markets recovered alongside the global capital markets primarily driven by positive vaccine developments. Continued investor confidence in a Brexit trade deal ahead of a formal agreement at year-end, coupled with the European Central Bank’s plan to show notable stability duringincrease the fourth quartersize and extend the time horizon of 2017 as improving growth prospects and increased appetite for risk in the region seemedtheir asset purchasing programs contributed to offset geopolitical and monetary policy concerns. As a result, the ICE BofAML European High Yield Index and thepositive returns. The Credit Suisse Western European Leveraged Loan Index delivered strong performancereturned 2.4% for 2020 compared to a return of 5.0% for the year-to-date period, returning 6.74%prior year. The ICE BAML European Currency High Yield Index returned 2.9% for 2020 compared to a return of 11.4% for the prior year.
The equity market experienced similar performance, rebounding in the second half of the year. In the U.S., the S&P 500 returned 18.4% for 2020 compared to a return of 31.5% for the prior year. Outside the U.S., the MSCI All Country World ex USA Index returned 10.7% for 2020 compared to a return of 21.5% for the prior year.
Despite the ongoing pandemic and 5.32%uncertainty surrounding the timing of recovery, private equity transaction volume rose during 2017, respectively. Economic growththe fourth quarter. We continue to believe careful target selection, a focus on high-quality assets and a differentiated view to drive value creation are keys to our funds’ performance in the current market environment.
Re-introduction of social distancing measures in Europe showed signs of strength as gross domestic product readings consistently beat expectations and the unemployment rate dippedU.S. contributed to lows not seen since January 2009.real estate fundamentals remaining depressed. The impact of the pandemic upon commercial real estate has varied significantly by property sector and geography. Incidences of asset-level distress are elevated, especially for retail and hospitality properties, which have borne much of the impact from COVID-19 restrictions. With many countries beginning vaccination programs, the overall trajectory of economies and real estate markets is positive.
NotwithstandingEuropean and U.S. publicly-traded real estate investment trusts (“REITs”) rose over the potential opportunities representedfourth quarter, boosted by market volatility, future earnings, cash flows and distributions are affected bynews surrounding the vaccine. In the U.S., the FTSE NAREIT All Equity REITs Index returned a rangenegative 8.4% for 2020 compared to a return of factors, including realizations24.0% for the prior year. In Europe, the FTSE EPRA/NAREIT Developed Europe Index returned a negative 13.1% for 2020 compared to a return of our funds’ investments, which are subject to significant fluctuations from period to period.24.7% for the prior year.
In 2018,2020, some of the considerations informingpertaining to our strategic decisions include:included:
• Our ability to fundraise and increase AUM and fee paying AUM. During the year ended December 31, 2017,2020, we raised $16.7$41.2 billion of gross AUM, both in commingled funds and separately managed accounts,SMAs, and continued to expand our investor base, raising capital from over 6585 different fundsinvestment vehicles and approximately 146358 institutional investors, including 78155 direct institutional investors that were new to Ares. Our fundraising efforts helped drive AUM growth of approximately 11.8%32% for 2017.2020. During 2018,2021, we expect that our fundraising will come from a combination of our existing and new strategies primarily in the U.SU.S. and Europe. During the year ended December 31, 2017, we earned approximately 1.1% on our FPAUM, which was consistent with 2016. As of December 31, 2017,2020, we also had $15.0$40.0 billion of AUM not yet earningpaying fees, which represents approximately $164.4$428.3 million in annual potential management fee revenue. Of the $164.4$428.3 million, $126.1$400.9 million relates to $11.8$37.1 billion of AUM available for future deployment. Our pipeline of potential fees, coupled with our future fundraising opportunities, gives us the potential to increase our management fees in 2018.
2021.
