As we initially discussed in an earlier post, Canadian managers of private equity, venture capital and other fund structures that are not regulated as “investment funds” under Canadian securities laws may, in the UK, be subject to marketing and related restrictions imposed by the Alternative Investment Fund Managers Regulations 2013 (the UK Regulations) when marketing alternative investment funds (AIFs) to professional investors in the UK pursuant to the UK’s national private placement regime.
The UK Regulations, which implement the European Alternative Investment Fund Managers Directive (the Directive), came into force on 22 July 2013. As required by the Directive, the UK Regulations effectively regulate a much broader array of fund structures than conventional alternative investment funds. While EU member states were required to implement the Directive prior to July 22, 2013, only 12 of 31 EU member states had completed full legislative transposition within the deadline. Many of these 12 member states will provide transitional relief from the obligations imposed by the Directive for a one (and in some cases two) year period.
Summary of Obligations imposed by the UK Regulations
Pursuant to the UK Regulations, Canadian alternative investment fund managers (Fund Managers) may market an EU AIF or a Canadian (or other non-EU) AIF to professional investors under the UK’s private placement regimes, provided the Canadian Fund Manager registers with the UK Financial Conduct Authority and complies with the following requirements in the UK Regulations (described in further detail below):
transparency requirements, including the provision of:
- an annual report
- information to investors prior to investment;
- on-going disclosure to investors;
- on-going reports to regulators;
portfolio company disclosure requirements, including:
- disclosure of acquisitions of “control”;
- disclosure of financing arrangements when “control” is acquired; and
- asset stripping restrictions.
The UK Regulations also require that Canada not be listed as a Non-cooperative Country and Territory by the Financial Action Task Force and that cooperation agreements have been entered into between the relevant Canadian regulators and the FCA. In Canada, the Ontario Securities Commission, the Autorité des marchés financiers, the Alberta Securities Commission and British Columbia Securities Commission have entered into memorandums of understanding with 34 European Regulators, including the UK’s FCA. In Ontario, the MOU is subject to approval by the Ontario Minister of Finance.
Small Fund Manager Exemptions
While Small Canadian Fund Managers (as defined below) are exempt from the majority of the UK Regulations’ requirements, they must still register with the FCA. Small Fund Managers are defined as those Fund Managers that, either directly or indirectly, through a company with which the Fund Manager is linked by common management or control, or by a substantive direct or indirect holding (i) manage portfolios of AIFs whose assets under management either do not exceed €500 million in total (in cases where the portfolios of AIFs consist of AIFs that are unleveraged and have no redemption rights exercisable during a period of five years following the date of initial investment in each AIF); or (ii) do not exceed €100 million in total in other cases (including any assets acquired through the use of leverage).
Small Canadian Fund Managers must give written notification to the FCA before marketing in the UK an AIF it manages. The notification must include a statement confirming that (i) the Fund Manager is the person responsible for complying with the implementing provisions relating to the marketing of the AIF; and (ii) the Fund Manager is a small Canadian Fund Manager.
Furthermore, the small Canadian Fund Manager must provide the FCA with such information as the FCA directs on the main instruments in which the Canadian Fund Manager trades and the principal exposures and most important concentrations of the AIFs that it manages.
UK Transitional Requirements
The UK Regulations grant a one year transitional period from July 22, 2013, which applies to Canadian Fund Managers that have managed an AIF immediately before July 22, 2013 and marketed that AIF in an EEA state before that date.
Non-binding Policy Statement PS13-05 issued by the FCA in June 2013 notes that “marketing” has a specific meaning within the context of the UK Regulations. The terms “offering” and “placement” are not defined in the UK Regulations; however, PS13-05 indicates that that an offering or placement will take place for the purposes of the UK Regulations when a person seeks to raise capital by making a unit or share of an AIF available for purchase by a potential investor and includes situations which constitute an invitation to the investor to make an offer to subscribe for the investment (i.e. an “invitation to treat”).
The FCA has advised that Canadian Fund Managers benefitting from the transitional provisions that wish to continue to market AIFs into the UK under the UK’s private placement regime after the end of the transitional period on July 22, 2014 should submit an application to be registered no later than April 22, 2014.
The UK Regulations stipulate that annual reports be made available by a Fund Manager for each EU AIF it manages (if any) and each non-EU AIF that is marketed in the EU within six months following the end of the financial year. On request, the annual report must also be provided to the AIF’s investors.
The principal items that the annual report must disclose include:
- balance sheet or statement of assets and liabilities and income and expenditure report;
- a narrative overview of results/report on activities on the financial year;
- any material changes in the information disclosed to investors under the UK Regulations during the financial year in question;
- the total remuneration paid by the Fund Manager to its staff members, the number of beneficiaries and, where relevant, the carried interest paid by the AIF;
- the aggregate amount of remuneration broken down by senior management and members of staff whose actions have a material impact on the risk profile of the AIF.
Annual reports for non-EU AIFs must be prepared in accordance with the accounting standards of the third country where the AIF has its registered office. Generally speaking, the accounting information given in the annual report for non-EU AIFs must also be audited in accordance with international auditing standards in force in the country where the AIF has its registered office.
Disclosure to Investors
For each non-EU AIF managed by a Canadian Fund Manager and marketed into the EU, the Canadian Fund Manager must make certain information available to investors prior to investment. This information includes a description of:
- the investment strategy and objectives of the AIF, and the types of assets in which the AIF may invest, the techniques it may employ, all associated risks and investment restrictions and details in relation to any leverage and collateral and asset re-use arrangements;
- a description of the procedures by which the AIF may change its investment strategy or investment policy;
- the main legal implications of the investment contract;
- the identity of the Fund Manager, the AIF’s depositary, auditor and any other service providers, along with a description of their duties and the investors’ rights in relation thereto;
- a description of how the Fund Manager complies with the requirements to cover professional liability risks under the capital requirement provisions;
- any delegated management or depositary function and any associated conflicts of interest;
- the AIF’s valuation procedure and pricing methodology;
- the AIF’s liquidity risk management, including redemption rights;
- all fees, charges and expenses (including maximum amounts) borne by investors;
- any preferential treatment received by an investor;
- the latest annual report (as described above);
- the procedure and conditions of issue and sale of units or shares;
- the latest net asset value of the AIF or the latest market price of the units or shares of the AIF according to the valuation provisions;
- historical performance of the AIF;
- prime brokerage arrangements;
- any arrangements made by the depositary to contractually discharge itself of its liability under the Directive, together with any changes with respect to depositary liability; and
- how and when periodic disclosures (described further below) will be made.
All information contained in a prospectus of an AIF will be deemed to have been disclosed.
Each Canadian Fund Manager must periodically disclose the following information to investors:
- the percentage of assets which are subject to special arrangements arising from their illiquid nature;
- any new arrangements for managing the liquidity of the AIF;
- the current risk profile of the AIF and a description of the risk management systems employed by the Fund Manager to manage market risk, liquidity risk, counterparty risk and other risks, including operational risk; and
- where a Canadian Fund Manager manages or markets in the EU an AIF employing leverage on a systemic basis, it shall disclose on a regular basis any changes to the maximum level of leverage permitted (including any right of re-use of collateral or any guarantee granted under the leveraging arrangement) and the total amount of leverage employed by the AIF.
Reporting to Regulators
Separate from the required disclosure to investors, the UK Regulations require a Canadian Fund Manager to provide the regulator in each EU member state in which the AIF is marketed with a significant amount of information as outlined below. Information provided to one EU member state may be accessible by other EU member states under information exchange mechanisms. In particular, information about leverage (described below) will be made widely available from one regulator to the next.
Information to be reported for all AIFs
A Canadian Fund Manager must provide EU member state regulators with information on:
- the principal markets and instruments in which it trades; and
- the principal exposures and concentrations of each EU AIF that it manages and each managed non-EU AIF that is marketed in the EU.
On request, a Canadian Fund Manager must also provide a quarterly list of all AIFs that it manages.
Information to be reported for All EU AIFs and All Non-EU AIFs Marketed in the EU
A Canadian Fund Manager must provide EU member state regulators with the following information for each AIF marketed in any EU member state:
- the percentage of the AIF’s assets subject to special arrangements arising from their illiquid nature;
- any new arrangements for managing the liquidity of the AIF;
- the risk profile of the AIF and the risk management systems employed;
- a description of the risk management systems employed by a Fund Manager to manage market risk, liquidity risk, counterparty risk and other risks, including operational risks;
- the main categories of assets in which the AIF is invested; and
- the results of stress tests, if any.
Information to Be Reported for AIFs that Use Leverage “on a Substantial Basis”
An AIF is considered to use leverage “on a substantial basis” when its exposure, as calculated according to the commitment method, exceeds three times its net asset value. The test incorporates both actual leverage represented by bank or margin borrowing and implicit leverage in derivative or trading techniques. Fund Managers managing AIFs that employ leverage on a substantial basis are required to make the following information available to regulators in each EU member state where the AIFs are marketed:
- the overall level of leverage employed by each AIF it manages;
- a breakdown between leverage generated through borrowing and the use of derivatives respectively;
- details of re-use (hypothecation) of assets under leveraging arrangements; and
- the identity of the five largest sources from which cash or securities are borrowed together with the amounts borrowed.
EU member states are specifically given the right to ask for additional information about leverage.
Portfolio Company Disclosure
The UK Regulations require notifications and disclosures by a Canadian Fund Manager managing an AIF that acquires certain holdings/control of portfolio companies that have their registered office in the EU. The definition of “control” and associated disclosure requirements vary according to whether an acquisition of certain holdings or control relates to a listed or unlisted company.
Definition of Control
In the context of the acquisition of an unlisted company, “control” is generally held to occur when an AIF holds more than 50% of the voting rights of an unlisted portfolio company.
Where a listed company is acquired, “control” is defined with reference to the Takeover Directive, which provides that the percentage of voting rights to give control is determined by the rules of the member state in which the listed company has its registered office. In many member states (including the UK) this is set at 30% although it varies in some other member states.
Notification of the Acquisition of Holdings and Control of Unlisted Companies
A Canadian Fund Manager must notify the competent authority of the voting rights in the unlisted company held by the AIF it manages when the AIF acquires or disposes of shares of an EU-domiciled unlisted company at the following trigger points: 10%, 20%, 30%, 50% and 75%.
A Canadian Fund Manager is also required to provide the following information to the unlisted company, its shareholders and the competent authorities within 10 working days of acquiring control of an unlisted company:
- the resulting situation in terms of voting rights;
- the conditions under which control has been reached, including information about the identity of the different shareholders involved, any natural person or legal entity entitled to exercise voting rights on their behalf, (and the chain of undertakings through which voting rights are effectively held); and
- the date on which the threshold was reached or exceeded.
In its notification, the Canadian Fund Manager must request that the board of directors inform the employee representatives (or where none, the employees) of the acquisition of control and the aforementioned information and use its best efforts to ensure the directors inform the employee representatives or employees, as applicable.
Disclosure on acquisition of Control of Unlisted or Listed Companies
On an acquisition of control of an unlisted or listed company, the Canadian Fund Manager must notify the company, the shareholders, and the competent authorities of:
- the identity of the Fund Manager(s) which manage the AIF(s) that have acquired control;
- the policy for preventing and managing conflicts, in particular between the Fund Manager, the AIF and the unlisted company;
- its policy on external and internal communication relating to the company and, in particular, its employees; and
- for acquisitions of unlisted companies – its intentions regarding the future business of the unlisted company and the likely repercussions on employment (this information does not need to be provided to the competent authorities).
As before, in its notification, the Canadian Fund Manager must request that the board of directors inform the employee representatives (or where none, the employees) of the acquisition of control and the aforementioned information and use its best efforts to ensure the directors do inform the employee representatives or employees, as applicable.
The Canadian Fund Manager must also disclose to the competent authorities and the AIF’s investors information on the financing of the acquisition when it acquires control of an unlisted company. The UK Regulations do not, however, define “financing” or specify which type of information relating to financing must be disclosed.
Additional Information to be Included in Annual Reports
Where unlisted portfolio companies are controlled by AIFs managed by a Canadian Fund Manager, the Canadian Fund Manager managing the AIF must:
- either request and use its best efforts to make sure that the annual report of the unlisted company includes the additional information set out below and the board of the company provides it to all employee representatives (or, where there are no employee representatives, directly to the employees) within the period permitted by the applicable national law for drawing up/filing such annual reports; or
for each AIF, include in the annual report (described above) the additional information relating to the relevant unlisted company set out below:
- a fair review of the development of the company’s business outlining the status of the business at the end of the period covered by the annual report;
- any important events that have occurred since the end of the financial year;
- the company’s likely future development; and
the information on acquisitions of own shares in accordance with the Second Company Law Directive, which requires information on:
- the reasons for acquisitions made during the financial year;
- the number and nominal value or, in the absence of a nominal value, the accountable par of the shares acquired and disposed of during the financial year and the proportion of the subscribed capital which they represent;
- in the case of acquisition or disposal for value, the consideration for the shares; and
- the number and nominal value or, in the absence of a nominal value, the accountable par of all the shares acquired and held by the company and the proportion of the subscribed capital which they represent.
Notification or disclosure is not required for the types of unlisted companies listed below:
- special purchase vehicles used to purchase or administer real estate; or
small and medium-sized portfolio companies (SMEs), defined as those companies that employ fewer than 250 people in the EU and either:
- have an annual net turnover not exceeding €50 million; or
- have a balance sheet total not exceeding €43 million.
The UK Regulations restrict distributions (including dividends and interest on shares), capital reductions, share redemptions or purchases of own shares by “controlled” portfolio companies during the first two years of ownership by an AIF.
Asset stripping provisions apply to both listed and unlisted portfolio companies. Under the UK Regulations’ restrictions, the Fund Manager may not “facilitate, support or instruct”, nor vote in favour of, any of the actions mentioned above and must use its “best efforts” to prevent them.
These “asset stripping” restrictions are only applicable to portfolio companies whose registered office is in the EU. The restrictions do not apply to special purpose real estate companies or to SMEs.
Not all payments to shareholders during the two year period are prevented by these restrictions, however generally speaking only “distributable profits” are allowed to be paid and then only provided the company’s net assets would remain at or above the level of the subscribed capital plus undistributable reserves.