As member states in the European Economic Area (EEA) enact their own regulations to support the Alternative Investment Fund Managers Directive (AIFMD), U.S. alternative fund managers are finding themselves on a tricky path when it comes to marketing their funds in the EEA.
AIFMD, which came into effect in July 2013, has created an alternative regulatory passport for investment managers to access European investors. The legislation impacts EU fund managers that manage alternative investment funds, those that manage funds established in the EU and non-European managers (including U.S. persons) that market Alternative Investment Funds (AIFs) in the EU. Failure to comply with its requirements could mean that managers are denied access to opportunities to raise capital in the EU.
Where once the strategy of ‘reverse solicitation’ was a common approach to raising capital in the EU, fund managers in the U.S. are now finding the path to the market blocked because of new marketing guidelines. They are also discovering that this passive marketing approach may leave them exposed to questions, or more alarmingly, sanctions, if they are found to have breached stricter and more defined marketing rules.
Under the AIFMD, marketing is defined as “a direct or indirect offering or placement at the initiative of the Alternative Investment Fund Manager (AIFM), or on behalf of the AIFM of units or shares of an AIF it manages to, or with investors domiciled or with a registered office in the Union.”
So what is reverse solicitation and how does it work in relation to this marketing definition? Broadly speaking, reverse solicitation occurs where the investor approaches the AIFM on his own initiative and there is no overt marketing approach from the AIFM. However, what constitutes an overt approach, vis-à-vis a passive approach, or reverse solicitation, may be interpreted differently from jurisdiction to jurisdiction and this is where U.S. alternative investment managers need to proceed with caution.
Some industry stakeholders are seeing reverse solicitation as a slippery slope, because of the difficulty in drawing a line between what is passive and what is active marketing.
That’s because with AIFMD coming into effect, individual countries are also changing their private placement regimes. The degree to which the directive is adopted varies from country to country, with some allowing reverse solicitation under explicit conditions. The private placement laws incorporating AIFMD into local law preclude this in several countries.
Any U.S. manager now distributing in Europe is essentially privately placing their fund without having it regulated by European regulators. After July 22, managers who do not register their funds will need to cease marketing to European investors, or rely on reverse solicitation. Reverse solicitation requires fund managers to make no active marketing effort towards investors, but to simply wait for investors to come to them. If the investors approach the fund manager, then the fund hasn’t actively marketed and there are certain circumstances where the fund can accept the capital.
However, these circumstances are reducing as each country comes out with its guidance. For example, the FCA (the Financial Conduct Authority in the U.K.) has recently clarified that a reverse solicitation needs to be more substantive than ‘we would like to find out more about you as a group.’ The solicitation needs to name the particular fund and then the fund manager may be allowed to provide information with regards to that fund.
The concept of reverse solicitation relies upon the belief that investors are actively seeking out new funds. Other than some fund of hedge funds, investors have not traditionally been proactive in tracking down new fund managers. To receive capital from European investors, fund managers are likely to need a marketing approach that allows them to actively contact investors. Those fund managers not willing to launch a European domiciled AIF would need to consider registering their offshore AIF under the National Private Placement Regime (NPPR).
One way to do this, some say, is a hosted or platform solution for managers, which provides the advantage of working with an experienced partner who is familiar with the regulatory requirements and who has the expertise to set up a product. The hosted solution brings other benefits, such as financial and resource savings.
Still, other industry advisers say there remains a role for reverse solicitation, but its application must be genuine. Rachel Fenwick, an associate attorney with Dechert LLP acknowledges that there is a lot of interest around reverse solicitation, but for fund managers eyeing extensive European activity, a lot of it comes down to budget. “For larger asset managers who either want to achieve or maintain a significant European presence, reverse solicitation is probably not the best option, while for others who are interested in Europe and want the flexibility to accept European investors, but don’t necessarily have the resources to commit to full compliance with AIFMD, it may be an option,” she says.
“Reverse solicitation probably costs the least, but is not without its obligations; managers should still carry out a thorough review of their policies and procedures to ensure they can legitimately rely on it,” she said.
But, to focus on reverse solicitation only as one problematic area is to take only a partial view of the AIFMD regulatory landscape.
“For U.S. managers, marketing into Europe is the first AIFMD concern. Striking the appropriate balance between the manager’s resource allocation and expected benefits is key. For some, the net inflow from Europe is not enough to warrant keeping active channels open. For others, it is a matter of assessing some particular countries’ requirements in terms of marketing and relying on reverse solicitation for others,” says Nicolas Fermaud, a New York-based attorney who is in charge of the U.S./Luxembourg desk at international law firm Allen & Overy.
Fermaud observed that managers with pan-European distribution are eager to access the passport immediately, whether by renting an AIF Manager or by setting up their own, depending on their size.
“Because of the variety of factors that come into play, there’s no one-size-fits-all solution (to AIFMD). It’s not just passport or just Article 42 marketing. Reality is more complex than that and reverse solicitation is part of the array of possibilities,” says Fermaud.
However, reverse solicitation also poses certain risks. “European managers will be reporting to their competent regulators and, while at first the amount of data may be daunting, regulators will eventually become good at analyzing it and determining which non-European funds taped into European markets. If there is a big influx, it could raise questions about how the EU manager was contacted, which in turn could lead to sanctions,” Fermaud states.
Reverse solicitation may pose other difficulties, in that the approach to marketing is not harmonized throughout Europe. For example, in the U.K., the HMT Regulations that accompany the AIFMD outline certain sanctions for contravening marketing guidelines as implemented in that country. A U.S. alternative investment fund that markets a hedge or private equity fund may be deemed to be committing a criminal offence (with possible fines and imprisonment) for marketing breaches.
Further, the agreement (e.g., the subscription agreement) entered into with the investor resulting from any unlawful marketing could become unenforceable against the investor, in which case the investor would be entitled to recover any money invested, as well as seek compensation for any loss sustained as a result of the investment.
U.S. managers should therefore proceed with caution with their overall marketing and especially with reverse solicitation. Even if EU regulators may be loath to take action where breaches of marketing guidelines occur, AIFMs could still face disgruntled investors who could claim unlawful marketing, hurting the Manager’s brand and potentially seeking to recover their investments.