Summary: The European Commission has published a draft package of measures aimed at reducing barriers to the cross-border distribution of investment funds. Whilst we endorse the specific policy objectives of removing inefficiencies and improving transparency for fund raisings in the EU, we have concerns in some areas. In this briefing we consider some key features of the proposals, focussing on the impact on AIFs and their marketing.
On 12 March 2018 the European Commission published a draft package of measures (consisting of a Directive and Regulation) aimed at reducing barriers to the cross-border distribution of investment funds. A key concern of the Commission is that differences between EU Member States on how marketing rules apply and big variations in fees and charges for registrations are reducing the amount of cross-border access to funds. The proposed approach involves aligning the rules between different legislative frameworks for investment funds (AIFMD, UCITS, EuVECAs and EuSEFs and money market funds). The culmination of various Europe-led consultations, surveys and other stakeholder strategies pursuant to one of the building blocks of the Capital Markets Union initiative, the draft legislation is open for comment until 7 May 2018.
Whilst we endorse the specific policy objectives of removing inefficiencies and improving transparency for fund raisings in the EU, we have concerns in some areas. In particular, the new simplified marketing rules may actually inhibit cross-border distribution of investment funds across Europe, by creating additional complexity and legal uncertainty for managers.
In this briefing we consider some key features of the proposals, focussing on the impact on AIFs and their marketing.
New definition of “pre-marketing” means the “marketing” phase is likely to commence much earlier than is currently the case under FCA guidance
The draft Directive introduces a definition of “pre-marketing” for the purposes of AIFMD (and which will also apply to the EuVECA and EuSEF regulations). This in itself is a welcome addition: the UK’s FCA had provided helpful guidance for AIFMs which mitigated the burden of seeking passports, in order to have preliminary discussions with potential investors on funds before they were ready for launch. Unfortunately, other EU regulators did not take a similar approach which has caused confusion for AIFMs and restricted the availability of funds for investors in those jurisdictions.
Under the proposals, “pre-marketing” will be defined as any promotion to professional investors of an investment strategy or idea where no fund has been established. Member States will be required to permit AIFMs to have pre-marketing discussions (without notification) provided that: investors cannot commit or subscribe; no documentation is provided which could amount to a prospectus, constitutional document, subscription form or similar (whether in draft or otherwise and regardless of whether the fund has been established or not); and that there is no reference to an established AIF. The proposal therefore falls considerably short of the position envisaged in the FCA’s guidance. In particular, it will be restricted to teaser documents (rather than, under current market practice, draft documentation for discussion and negotiation with potential investors) and would not permit discussions with retail investors however sophisticated or wealthy. A current conundrum is likely to be exacerbated, where early activation of the passport mechanism (when copies of the PPM and fund constitutional documents have to be provided to the national competent authority (NCA), i.e. the regulator) means that there are likely to be subsequent amendments to the fund documentation over the course of investor negotiations. On each such occasion where those updates are “material”, one month’s advance notice has to be given to the regulator, with inherent potential delays and cost implications on fund raising activities. Besides this, the commercial realism preying on an AIFM’s minds, that there is a chance that the fundraise will not go ahead even though authorisation is necessary first.
We are concerned that, although not expressly stated in the draft Directive, anything beyond these restricted activities will automatically be deemed to constitute marketing. There is, however, a possibility that a grey area can remain where some regulators, such as the FCA, continue to take the view that marketing can commence at a later stage, with other regulators taking the position that they already do. We would hope that the FCA’s pragmatic approach to AIFMD marketing (along with other regulators, such as Luxembourg’s CSSF) will remain in place at least until actual transposition of the new rules. On the positive side, this development does provide some certainty for AIFMs wanting to market in those Member States who have provided little, none or more onerous guidance on marketing.
The draft Directive clarifies that an AIFM cannot rely on reverse solicitation following the “pre-marketing” of a fund with similar features. Nonetheless, we see this as no more than confirming the position as it currently stands.
A universal set of marketing requirements
The draft Regulation introduces a universal set of marketing requirements for AIFMs (and UCITS management companies): including that all marketing is identifiable as such; that investment risks and rewards are presented with equal prominence; and that all information is fair, clear and not misleading and does not contradict any information to be provided to investors before they invest.
We do not think that these additions will change normal expectations of FCA-authorised firms who already need to ensure that all communications comply with the FCA’s requirement to be fair, clear and not misleading.
No more gold plating on fees and charges; more transparency and harmonisation
There are welcome proposals around fees and charges to iron out some operational inconsistencies, including that they are to be charged on a proportionate basis to supervisory work carried out; that NCAs are to make fee information, national marketing rules and requirements and calculation methodologies publically available. ESMA also seeks to gain additional powers and oversight: it will create and maintain a central online interactive database of funds being marketed across the EU; and has enhanced powers to draft regulatory technical standards to develop standard notification forms, templates and procedures. Given that the explanatory memorandum to the draft Directive says that only 3% of AIFs (and 37% of UCITS) are currently registered to be sold in more than three Member States, our fear is that increasing the EU-level oversight and direction may simply add to the burden on, and costs for, managers in conducting a fund-raising.
Consistent provision of facilities for retail investors, but no need for a local physical presence
Under UCITS, managers are required to make a facilities agent available where there are cross-border sales. Some Member States have interpreted this as requiring local agents to be appointed to perform particular roles which has added to the costs and complexity of cross-border marketing. Whilst these measures aim to remove some of those hurdles (and in particular will make it clear that managers can themselves provide that role on a cross-border only basis), the downside is that a similar role is being introduced for the first time into AIFMD where there is marketing to retail investors.
Other proposals of note
A selection of some other issues which form part of the proposals.
- A new de-registration procedure when an AIFM wants to discontinue marketing in a Member State and where certain threshold conditions are met (effectively an AIFM’s activities have become insignificant in a particular Member State). On first blush, this would appear to be a helpful provision which could reduce the burden on managers who ultimately decide not to go ahead with, or are unsuccessful in, a particular Member State. However, given the potential need to obtain a passport earlier in the fund-raising process, managers are in turn likely to have a greater number of passports than they currently do. Furthermore, this de-registration procedure will only be available where the fund either has no investors in a Member State, or no more than 10 investors holding no more than 1% of the AIF’s AUM (in aggregate). Where there are investors, the AIFM must offer to redeem out their interest. In the context of a private AIF with a small number of investors, this is likely to be an impracticable level. It is also unclear whether the offer of such redemption rights could result in the AIF being deemed to be open-ended (and so removing the availability of a PE AIF depositary under article 21(3) paragraph 3 of AIFMD).
- Specific turnaround times are to be imposed on regulators to inform AIFMs/its home Member State either where planned changes to marketing documentation that has been submitted is not in compliance with AIFMD and cannot therefore be implemented (20 working days’ notice); or conversely where changes do not affect compliance and are accepted (one month’s notice).
- ESMA’s guiding hand is a common thread in the draft legislation, on areas such as requirements for marketing communications, as well as the content of information and standard forms of notification to be made available to it by NCAs.
What is not included
Non-regulatory barriers such as tax are outside the scope of these proposals. There are a few areas of detail which were raised in some responses to the European Commission’s June 2016 consultation but which have been left unaddressed and which could have provided more flexibility: for instance, the professional investor definition; depositary requirements and a voluntary passport for sub-threshold managers. Also there is nothing to help the industry adopt a common approach in order to assess materiality and therefore whether or not a specific planned change to authorisation or marketing materials submitted to an NCA requires notification. We assume that these are considered ancillary matters that are therefore unlikely to get picked up now.
The implementation of the draft Directive and Regulation is due to be synchronised, to take effect two years after coming into force, which will be after the date of the UK’s scheduled withdrawal from the EU. We think the most sensible approach is to work on the basis that UK AIFMs will be subject to the new rules, and to plan on that basis. Pending feedback from the consultation, the proposals will be discussed by the European Parliament and the Council. The legislation cannot be considered in isolation. For instance, we also await feedback from the KPMG survey (which closes on 30 March 2018) on a broad review of the functioning of AIFMD. Other wider laws and initiatives to consider alongside these proposals include MiFID II, PRIIPs, the Benchmark Regulations, fee scrutiny (by both ESMA and the FCA) and the review of ESAs.