In cases where a US investment adviser appoints an EEA sub-adviser, the parties concerned will need to analyse which entity will be the AIFM. Whether such arrangements relate to group entities or third parties, the parties may wish to avoid the EEA manager being deemed the AIFM in relation to the fund concerned. This is a potential risk if the activities of the EEA sub-adviser involve portfolio management or risk management in relation to the AIF concerned.
US entities (including US mutual funds, real estate funds and all other non-UCITS managers) investing in Europe through an EEA sub-adviser will need to consider this issue carefully.
Why is it important whether the AIFM is in the EEA or not?
An EEA AIFM will be fully subject to AIFMD, which will impose a wide range of structural and operational compliance constraints on the AIFM as well as, potentially, its delegates – including in regard to remuneration policy. EEA AIFMs also need to ensure that even non-EEA AIFs marketed in the EEA have appointed a depositary and comply with certain other requirements, which may significantly increase operating cost. Non-EEA AIFMs, on the other hand, need only to ensure that the transparency, disclosure and reporting requirements (discussed earlier in this note) are observed.
AIFMs must do more than just give advice
If the activities of the EEA sub-adviser consist solely of non-discretionary investment advice (i.e. making recommendations but not exercising final investment discretion) this would not generally be considered “portfolio management”. Consideration would need to be given to any risk management performed by the EEA sub-adviser, but overall it is unlikely that it would be the AIFM. Restricting the sub-adviser’s activities to non-discretionary advice only may, therefore, be a workable solution. However, the more frequently traded the portfolio is, the harder this model will be to operate; particularly if decisions need to be made quickly to react to market news or movements. It is most commonly used at present (in the UK at least) in the context of private equity and other illiquid asset classes.
Is the ‘letter-box’ test applicable to US managers?
If the EEA manager needs to exercise discretion over the portfolio, this raises the possibility that it could be viewed as the AIFM in relation to the AIF concerned, notwithstanding that it does not contract directly with the AIF. The question the relevant member state regulator should be asking here is “does the EEA entity have the correct authorisation?” – or in other words “is it correct to conclude that it does not need to be authorised as an AIFM?”. Although the letter-box test is contained in EU legislation that is not directly applicable to US investment advisers, national regulators in Europe may apply letter-box principles in assessing “inward” delegation structures, whereby US entities delegate to entities in Europe. Accordingly, the EEA manager should be prepared to show that its lead manager in the US would pass the letter-box entity test (see "Anti-Letter-box Provisions").
Practical steps: delegating to an EEA sub-adviser
Review all mandates for the management of open and closed ended funds to identify any that are AIFs.
Review management structures and identify the AIFM for each (including whether a new entity should be created for this purpose).
If it is not intended for the EEA sub-adviser to be an AIFM, it will be necessary to review overall structure to ensure that this will not be the case, taking advice as appropriate.
If the EEA sub-adviser will be an AIFM in any case (for example, because of other business it has), it will be important for the US investment adviser to understand how and to the extent that will impact the relationship.
Consider the impacts of the identified management structure and how this interfaces with marketing plans.