Setting up and managing an investment fund typically involves some high barriers to entry. However, for those whose investment objectives include both profit and positive social impact, a regulatory-light regime exists for so-called ‘Social Entrepreneurship Funds’ (SEF) managed by smaller managers (including new managers).

In this article, Simon Sutcliffe outlines the key considerations and requirements of managers for setting up a SEF.

What is a SEF?

The term is a regulatory classification and ‘brand’ name, which denotes that a fund invests a minimum proportion of its assets in impactful investments. In its legal form, strategy and investor terms, it can otherwise be like any other for-profit private investment fund. For example, it could invest in venture capital, credit, real estate or infrastructure. There are no geographic restrictions on where it makes its investments, so a SEF can pursue its financial and impact goals anywhere in the world. A SEF can either be internally managed or have a separate entity as its manager.

Originally a creation of European Union law, SEFs were introduced under the EU SEF Regulations 2013 (as subsequently amended by the EU SEF Regulations 2017) and the umbrella of AIFMD (the 2011 EU Alternative Investment Fund Managers Directive (AIFMD)). The SEF regime has been continued (and adapted) in the UK following Brexit.

What are the key benefits of setting up a SEF?

A SEF is one of a limited number of fund types that can be established and managed by a ‘small registered alternative investment fund manager’ (a small AIFM), meaning having less than €500m assets under management. The significance and importance of this is that the intended manager does not need to obtain authorisation from the Financial Conduct Authority (FCA), an otherwise normal requirement for fund managers. Instead, the manager of the SEF undertakes a ‘registration’ process with the FCA, with a 2-month application turnaround period and thereafter, more limited ongoing compliance requirements than apply to an authorised firm.

From the potential investors’ perspective, the SEF ‘brand’ is designed to be attractive and recognisable to investors as a means of impact investing, and the manager’s registration with the FCA and ongoing regulatory obligations may give a level of comfort to investors, as contrasted with other less regulated alternatives. As such, a SEF designation should, in theory, be a positive factor in investor allocation decisions.

What responsibilities does the manager have?

A manager (or the SEF itself if it is internally managed) must comply with a number of defined responsibilities, mostly derived from the SEF Regulations of 2013 and 2017 (as retained and modified in the UK, post-Brexit). These include standards and obligations related to the good conduct and property marketing and management of a SEF, in such areas as professional conduct, management of conflicts of interest, investor disclosure requirements, producing an annual report and valuation procedures, among others. A minimum own funds/capital requirement applies, starting from €50,000.

What type of investors can invest in a SEF?

A SEF would usually be an unauthorised, private fund (meaning the fund itself has not been authorised by the FCA and so is not suitable for retail/public offering), so it would be restricted in the UK to a list of eligible professional, high-net-worth or sophisticated, or other eligible investors under the applicable UK promotion and marketing rules.

Marketing of a UK SEF in EU member states is currently under national private placement rules or the provisions under the AIFMD for pre-marketing registration. The landscape for marketing in the EU will become more homogenous for non-EU fund promoters with the advent of the 2019 EU Regulations on facilitating the cross-border distribution of funds. These regulations strive to address the current patchwork of regulatory approaches to what is, and is not, regarded as ‘marketing’ under the AIFMD and thereby requiring prior registration.

What are the investment conditions for a SEF?

The fund must invest at least 70% of its assets in investee undertakings each of which:

  • Has the achievement of measurable, positive social impacts as its primary objective by:
  • providing services or goods that generate a social return;
  • employing a method of production of goods or services that embodies its social objective; or
  • providing financial support exclusively to social undertakings as defined in the two bullet points above.
  • Puts purpose before profit, in the sense that its policies on distribution of profits does not undermine its primary objective.
  • Is managed in an accountable and transparent way, in particular by involving workers, customers and stakeholders affected by its business activities.
  • Is not in a FATF non-cooperative country and territory and has signed agreements with the UK regarding compliance with the OECD Model Tax Convention on Income and on Capital and ensuring an effective exchange of information in tax matters.
  • Is not traded on an exchange or multilateral trading facility.

Is this the only way I could set up an investment vehicle for an impactful purpose?

The SEF regime is potentially an interesting option for an impact investment manager, depending on their circumstances, preferences and goals, but no, this is not the only way. Other approaches could include, for example, the appointment of a ‘regulatory host’ alternative investment fund manager with the sponsor acting as an adviser or consultant, an offshore unregulated fund structure, or indeed full FCA authorisation. Which approach is best for a set of circumstances would require a comparative assessment of suitable options and professional advice.