AIFMD: Impact on US Investment Advisers - June 2013: Marketing funds in the EEA

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From 22 July 2013, subject to certain transitional arrangements, new rules will apply in relation to the “marketing” of AIFs to investors domiciled in or with a registered office in the EEA.

Whereas EEA AIFMs will be permitted access to a UCITS-style pan-EEA marketing passport allowing the marketing of EEA AIFs to professional investors, US and other non-EEA AIFMs will not have access to this, at least for the first two years.

In relation to US and other non-EEA AIFMs, individual member states have a free hand to decide whether to permit private placement and, if so, to determine the extent of their rules in this area - and the results will vary member state by member state.  Certain member states are expected to be very restrictive in this regard, some will be permissive.  For those permissive member states that do permit marketing by private placement (the so called “national private placement regimes”), there will be new regulatory filing, reporting and disclosure requirements. 

Accordingly, once AIFMD takes effect from 22 July 2013, US investment advisers wishing to raise capital from European investors for AIFs they manage (typically Cayman, Delaware, or other non-European funds) will have a number of options, each of which is discussed in more detail below. See also the Q&A section at the end of this OnPoint for guidance on some specific marketing scenarios, such as communication with existing investors.

Routes to European capital after 22 July 2013

  1. Transitional arrangements. Certain jurisdictions (e.g. the UK and Germany) are expected to permit certain existing fundraising to continue under pre-AIFMD rules for up to a year.
  2. Private placement, where permitted.  Both the investor’s home state (e.g. where it is domiciled or where its registered office is located) and/or the location in which marketing takes place could be relevant in determining which rules apply to any given scenario. The availability of this route is dependent on, amongst other things: (a) the relevant member state permitting such marketing at all (some will not); and (b) the relevant co-operation arrangements with competent authorities where the AIF is established having been entered into. Significant additional compliance requirements will also apply.
  3. Non-Solicited Sales. The acceptance of investors on a “passive” or “reverse solicitation” basis will fall outside the AIFMD restrictions on marketing. The relevant offer or placement must be at the investor’s initiative rather than that of the investment adviser or any agent of the investment adviser. Such sales may include those initiated via capital introduction events, investment consultants and other third parties, if structured properly.
  4. Outside scope marketing. Some "pre-marketing" is outside scope.  Also, marketing investment opportunities that are outside the scope of AIFMD (e.g. managed accounts or UCITS) is not restricted by AIFMD.
  5. Access the EEA marketing passport. This will require the establishment of an EEA AIFM and EEA AIF and accordingly will involve full AIFMD compliance.

Route 1: Rely on transitional arrangements

Certain jurisdictions (the UK and Germany included) are expected to allow US investment advisers and other “third country” AIFMs, to continue pre-existing marketing campaigns under transitional arrangements. These arrangements are expected to continue up to July 2014.

In order to rely on transitional arrangements, US investment advisers will need to know the eligibility criteria in each relevant jurisdiction. Transitional reliefs may only be available if investment-ready fund documentation has been made available to investors in the jurisdiction prior to 22 July 2013.

Accordingly, any US investment advisers looking to take advantage of such transitional arrangements will need to consider now whether any additional steps are necessary in order to ensure that they can get the benefit of these reliefs.

We are monitoring the availability of these reliefs closely and can advise further as required.

Route 2: National private placement regimes

No EEA single market for marketing by US managers

The term "private placement" in an AIFMD context refers generally to marketing to professional investors without a passport. As at present, the permissibility (or otherwise) of private placement in any given EEA member state by US AIFMs will be a matter for the national law of that member state. The final position to be adopted by many EEA member states is still evolving. However, with some potentially significant exceptions, we broadly expect member states which are currently restrictive to stay restrictive and those which are currently permissive to preserve some form of private placement regime. As a whole, however, we expect the kaleidoscope of formal and informal private placement routes reflecting laws or practices of long standing to be replaced with a more formal set of private placement regimes or outright prohibitions on marketing. This heightens the level of regulatory scrutiny and consequently the level of marketing discipline required from promoters and their agents.

Importantly, given the volume of investors in the UK, the regime in the UK will remain broadly permissive of private placement. This position which is set out in draft HM Treasury regulations, which have been the subject of industry consultation but which at the time of writing have not been made final.

We are monitoring the position in all EEA member states closely.  For more information on how Dechert can help with your European marketing compliance requirements, please contact the authors or any member of our AIFMD team.

Co-operation arrangements

A pre-requisite for private placement under AIFMD is that the relevant EEA member state concerned must have in place “co-operation arrangements” with the regulators in the jurisdiction of the AIF and of the AIFM (if non-EEA).  ESMA3 is coordinating these arrangements by negotiating with non-EEA regulators. 

At the time of publication, ESMA has announced its approval of co-operation arrangements with 34 regulators, including the SEC and Federal Reserve (but, notably, not the CFTC), as well as the Cayman Islands Monetary Authority and others. This is a key step in securing the availability of the private placement route for US investment advisers marketing non-EEA funds in Europe.

The co-operation arrangements are embodied in template Memoranda of Understanding (MoUs) which now need to be converted into bilateral agreements signed by each EEA securities regulator and the relevant non-EEA authorities. Whilst we expect that many of the key regulators will sign these MoUs prior to 22 July, it is likely that some will not. 

Registration procedure

US investment advisers qualifying as non-EEA AIFMs are likely to need to register private placements in member states in which they are marketing by way of private placement. This will involve filing certain documentation about the AIF and the non-EEA AIFM with the applicable national regulator and may take the form of a notifaction/registration or application for approval, depending on jurisdiction.

New disclosure requirements

When marketing (as defined by the AIFMD) under national private placement regimes, a US investment adviser will be subject to the new compliance requirements described below.

The private placement memorandum, or other marketing and disclosure material, will need to contain new AIFMD pre-sale disclosures. Some of the required disclosures will be of commercial interest to investors and, therefore, in documentation already – others will not. Required disclosures include (amongst others):

  • investment strategy and objective (noting that regulators may not tolerate some of the very wide and non-specific disclosures in this regard that are currently used);
  • redemption and liquidity management policies;
  • professional indemnity insurance levels;
  • delegated functions (including management and custody);
  • valuation procedures;
  • fees, charges and expenses;
  • how the fair treatment of investors is ensured (including, potentially, detailed side letter disclosures);
  • information on latest valuations and prices;
  • information on historic performance; and
  • latest annual report (this is where remuneration disclosures are contained – see below).

Required periodic “post sale” disclosure requirements include:

  • material changes in information disclosed;
  • the percentage of assets subject to special arrangements on liquidity;
  • new arrangements for managing liquidity;
  • the current risk profile of the AIF and risk management systems employed; and
  • total leverage employed.

Such "post sale" disclosures may be required (and made) as part of an AIF’s annual reporting package, but may also need to be communicated more frequently in response to specific events.

Annual report (including remuneration disclosure)

The AIFM will need to make available to investors an annual report for each financial year, which will need to cover, amongst other things:

  • balance sheet and income/expenditure statement;
  • report on activities for the financial year;
  • material changes to fund terms or disclosures during the financial year;
  • total remuneration, split into fixed and variable remuneration paid by the AIFM to its staff (including the number of recipients);
  • total remuneration broken down by senior management and members of staff of the AIFM whose actions have a material impact on the risk profile of the AIF; and  
  • a breakdown of the total remuneration amounts in relation to each AIF, so far as practicable.

It is unclear at present whether particular jurisdictions will require such disclosures to be ‘back-filled’ in relation to preceding periods. We hope that regulators will be pragmatic about this.

Carried interest is seen as “remuneration” for the purpose of these disclosures. The position of profit distributions to equity owners of the business is less clear, but there is a danger that some such distributions might also fall within the scope of “remuneration”. Accordingly, it can be seen that careful consideration as to which entity will be the AIFM is critical as this determines the disclosures required.

Transparency requirements: Europe’s “Form PF”?

The AIFMD will introduce new regulatory reporting requirements for US investment advisers which either manage an AIF domiciled in the EEA or which market a non-EEA AIF within the EEA. Although reporting will be made to EEA national regulators, the European Commission has adopted a standard form template to be used throughout the EEA.

Some parts of the AIFMD reporting form have analogues in SEC Form PF, but many do not. In general, the AIFMD form is less focused than Form PF on reporting broken down by fund type. The AIFMD form has a common set of reporting requirements for all funds, regardless of fund type, although references to, for instance, long and short positions and counterparty risk indicate that it is primarily targeted at hedge funds (with some questions which may be difficult to answer for non-hedge funds).  As a consequence, reporting by funds other than hedge funds (such as private equity and real estate) will take a very different form in the AIFMD form compared with Form PF.

Private equity provisions 

Managers of AIFs which acquire control positions in listed and unlisted companies in the EEA (e.g. most Europe-focused private equity funds) will, subject to certain exceptions, be required to comply with new provisions specific to private equity, including:

  • A requirement to notify the company, shareholders and regulators of acquisitions of major holdings in unlisted companies when certain thresholds are passed (starting at 10%).
  • A requirement to include additional information in the annual report (including future development plans).
  • The so-called “asset stripping” provisions which restrict dividend recapitalisations and other returns of capital for the first two years of portfolio company ownership.

Application of “asset stripping” provisions to US AIFMs Marketing in Europe

AIFMD imposes restrictions on distributions, capital reductions, share redemptions and purchases of own shares by a “controlled” portfolio company during the first two years of ownership of that company by an AIF, including one managed by a non-EEA AIFM. 

The restriction affects only portfolio companies who have a registered office in the EU and that are not special purpose real estate companies or “small and medium enterprises”4.

Whether a portfolio company is “controlled” for these purposes depends on whether it is unlisted or listed. An unlisted company is generally “controlled” if the AIF holds more than 50% of voting rights. The test for when a listed company is controlled varies from member state to member state. In most EU member states, including the UK, a listed portfolio company would be “controlled” once 30% of voting rights are held.

The asset stripping restrictions apply to the AIFM rather than the portfolio company, and the AIFM is required to use “best efforts” to prevent any asset stripping steps from being taken. The restrictions are aimed at manipulating the value of a portfolio company through return of capital (e.g. a dividend recapitalisation) rather than outright disposals. Payments that are made out of certain line item reserves continue to be permitted. 

Additional requirements

Some member states will impose additional compliance requirements in order to access national private placement regimes – for example, the requirement to appoint a depositary. We can advise further on these access conditions as required.

Route 3: Non Solicited Sales (reverse solicitation)

Non-solicited sales will not constitute marketing for the purposes of AIFMD. Accordingly, AIFMD does not restrict the ability of EEA investors to invest at their own initiative, notwithstanding that they may be domiciled or have a registered office:

  • in a member state where private placements are permitted but the AIF has not been registered for private placement; or
  • in a member state where private placements are not permitted.

Reverse solicitation is not about the investment adviser accessing investors, it is about investors accessing the investment adviser. Firms which adhere to that fundamental principle – and can back it up with evidence – should find they can still accept investment from EEA investors, unaffected by AIFMD. However, the concept of reverse solicitation will be approached differently by different regulators and, therefore, advice on its scope should be taken before relying on it. Almost by definition, the countries where reverse solicitation is likely to be most relevant are those which are hostile to private placement - so care is advised.

Any manager looking to rely on reverse solicitation should maintain a robust compliance process which can also provide evidence that the sale was made on this basis. This is important not just in the context of regulatory compliance, but also given the private law actions that AIFMD breaches could give rise to (in short, the danger of an investor seeking to argue that the fund was “mis-sold” in breach of marketing restrictions and they are entitled to their money back).

Factors to consider:

  • Are intermediaries acting on behalf of the AIFM, AIF, investor or their own account?
  • Does the whole pattern of contact with both new and existing investors back up the reverse solicitation?
  • Does the manner in which subscriptions are processed on behalf of the AIF back up the reverse solicitation?
  • Are promotional and other materials and website content and procedures sufficiently robust?

Reverse solicitation is not a new concept - it has been relied upon for some time in various jurisdictions. The AIFMD does, however, throw a new focus on the topic so managers are well advised to review their understanding of the process and related sales procedures.

Route 4: Outside Scope Marketing

Pre-marketing may be excluded

Much of the “real world” marketing activity in connection with an AIF is likely to fall outside the concept of “marketing” as defined by AIFMD. This should be assessed in terms of an overall course of action rather than purely in terms of particular documents, but it does mean that certain documentation (such as flip-books or draft fund documentation) could potentially be communicated to investors without being deemed “marketing” for AIFMD purposes. This is helpful as it means that, for example, compliance with the registration, disclosure and transparency requirements attendant upon “marketing” could be deferred or potentially avoided.

It will be important for those relying on this concept to obtain clear guidance on the parameters of such “pre-marketing” in each relevant jurisdiction, along with associated rubrics and compliance procedures advisable to support the regulatory analysis. It is important to note that:

  • such activities may well still be subject to national regulatory requirements (e.g. in the UK, such “pre-marketing” activities may well amount to regulated “financial promotion”); and
  • unless there has been a “reverse solicitation”, marketing within the meaning of AIFMD may well be necessary in order to consummate the sale – thereby triggering registration and other compliance requirements in due course.

See also the Q&A section at the end of this OnPoint for further discussion on certain pre-marketing issues, including guidance on continuing discussions that are already in progress prior to 22 July.

Marketing non-AIFs

Discussions around managed accounts, UCITS and investment strategy or team generally, without reference to an AIF, in principle should be outside scope of AIFMD. Again, capital introduction events may have a role to play here, provided they are structured so as to avoid promotion of particular AIFs on behalf of their managers. Remember, however, that these activities are still potentially within the scope of other laws and regulations in member states which need to be complied with.

Please note, multiple managed accounts managed on a lock-step basis, or “funds of one” which do not contain appropriate restrictions on further investment, may constitute AIFs.  Accordingly, careful structuring may be required to ensure that such arrangements remain outside the scope of AIFMD.

Route 5: EEA Passport marketing

The EEA passport, which allows AIFs to be marketed on a pan-European basis under an EEA “marketing passport” regime, will (initially, at least) only be available to EEA AIFMs in relation to EEA domiciled funds. Accordingly, US investment advisers looking to use the passport will need to establish an EEA AIFM, which will be subject to full compliance with the AIFMD. This can be done in a number of ways. The US adviser may already have an authorised affiliate in London or another European jurisdiction and could establish an AIFM in parallel to or in place of that entity. Alternatively, a self-managed AIF or local management company could be established in Ireland, Luxembourg or an alternative EEA jurisdiction. To the extent that the EEA AIFM delegates collective investment services to the US investment adviser, the matters discussed under “Sub-Adviser to EEA Manager below will also be relevant. 

Marketing: practical steps

Generally:

  • Understand marketing plans. What are the fundraising objectives over the next 12-24 months? In which  jurisdictions and by which route are investors expected to invest?
  • Review ongoing conversations with prospective investors. Consider whether any steps should be taken prior to 22 July and on what terms such discussions can continue afterwards.
  • Understand whether anything needs to be done now in order to ensure that a transitional relief is available in a particular jurisdiction.
  • Review marketing compliance procedures. Understand how evolving rules will be monitored.
  • Review website compliance and communications with existing investors.

If private placement will be used:

  • Consider who will be the AIFM, including potentially establishing a new entity. Everything flows from this.
  • Monitor co-operation arrangement progress.
  • Review relevant PPMs and related material for transparency compliance requirements. Will required information be disclosed in PPMs or in supplementary documents?
  • Start to assess annual report and other provisions. 
  • Start to prepare for remuneration disclosure. Assess what remuneration and which funds are in scope for disclosure.
  • Start to prepare for regulatory compliance requirements (transparency and regulatory reporting) in each relevant jurisdiction.