The European Commission has put forward amendments to the 2011 Alternative Investment Fund Managers Directive that includes clarifying and setting out uniform rules on what constitutes ‘pre-marketing’ activity, a topic that has been an area of controversy since the directive came into force in 2013. However, the rules have been eased in a fresh draft following criticism from the alternative fund industry.
The Commission published a draft directive in March 2018 amending both the UCITS and AIFMD regimes governing the cross-border distribution of retail and alternative collective investment funds, as well as a proposed regulation on facilitating cross-border fund distribution, as part of a legislative package designed to help complete its Capital Markets Union project.
The legislation aims to make possible pre-marketing of alternative funds in EU member states where it is not currently permitted. However, the proposal sparked controversy because in some cases AIFMs would find themselves subject to more restrictive rules than in the past, especially under regulators such as the UK’s Financial Conduct Authority or Luxembourg’s Financial Sector Supervisory Authority (CSSF) that have been accommodating toward pre-marketing under the existing, less prescriptive AIFMD requirements.
Differences of interpretation
At present, an EU alternative investment fund manager must notify its home regulator of its intention to market an EU-domiciled alternative fund either in its home jurisdiction or another EU member state. While the directive provides a definition of ‘marketing’, interpretations of this in practice vary from one country to another.
Some EU members treat any initial contact with a prospective investor as marketing, while others allow a degree of pre-marketing contact without the requirements of the AIFMD being triggered. The proposed directive would incorporate a definition of pre-marketing into the AIFMD and to specify the conditions under which it is permitted.
Under the Commission’s original draft, pre-marketing was defined as the direct or indirect provision of information on investment strategies or investment ideas by or on behalf of an AIFM to professional investors domiciled or registered in the EU, to ascertain their interest in a fund that has not yet been established.
Threat to existing investment practice
This activity would in the future be permitted throughout the EU, without any requirement on AIFMs to notify regulators when they did so. However, the Commission’s proposal excluded information that relates or refers to an existing fund, enables investors to commit to acquisition of units or shares of a fund, or that amounts to a prospectus, constitutional documents of a future AIF, offering documents, subscription forms or other documents that would enable investors to take an investment decision.
The draft proposed that where a professional investor subscribes to a fund established following pre-marketing activity, this would be considered the result of marketing, as would be the case for funds managed or marketed by an EU AIFM that had engaged in pre-marketing of a not-yet-established AIF with similar features.
The Commission’s proposals came under criticism from industry practitioners and advisers. They noted that by not permitting the circulation of fund documentation in draft form to investors without a marketing authorisation, the revised rules would require significant changes from existing practice for alternative investment funds.
Sounding out the market
It would further complicate the process of dealing with investors in jurisdictions whose domestic private placement regimes already entail a longer investment process. In some cases, it could oblige AIFMs to comply with the marketing passport conditions before a final decision to establish a fund had been made.
The issues raised regarding the original proposal appear to have been taken into account in a revised version of the legislation published by the EU Council on June 15, which is seen as significantly closer to the more liberal interpretation of AIFMD marketing authorisation requirements adopted by member states that are centres of the asset management and fund sectors.
The changes would permit AIFMs to sound out the market of prospective professional investors before documents are finalised ahead of a fund’s launch, the point at which AIFMs would probably be deemed to be carrying out marketing activities requiring authorisation or notification under the AIFMD.
Under the revised conditions for pre-marketing, investors would not be able to subscribe to the prospective fund, and indeed no subscription documents would be available. Any constitutional and offering documents of not-yet-established AIFs would be in draft form only, would not constitute an offer, and would have to state clearly that they were incomplete, subject to change and were not to be relied upon. AIFMs would be required to document market-sounding activities, including details on when and where they were carried out, and be ready to share these with regulators on request.
If the Council’s proposals become law, EU and EEA member states that currently do not permit any pre-marketing activity would be required to allow managers to hold initial discussions with investors and test market appetite for their proposed fund before obtaining a marketing passport or submit notifications under the AIFMD rules governing national private placement regimes.
The Council’s amendments also state that any subscription to an AIF within 18 months of pre-marketing that either referred to the AIF or was established as a result of pre-marketing will be considered to be the result of marketing and subject to notification/authorisation, a new approach that would rule out reliance on reverse solicitation in certain circumstances.
Other amendments to the AIFMD proposed by the Council include changes to measures setting out the procedures and conditions for AIFMs seeking to discontinue marketing activities in a particular member state. In the Commission’s original draft, firms could simply notify other EEA regulators for which they had marketing authorisation for a particular fund that they no longer wish to market, cutting their costs on reporting and fees – but only if the jurisdiction was home to fewer than 10 investors in the funds with shares or units representing less than 1% of the fund’s assets.
AIFMs were also obliged to offer to repurchase units from investors in these jurisdictions, even if the fund was closed ended and not permitted to make redemptions. In the compromise proposals, the threshold is 5% of assets with an unlimited number of investors, and closed-ended AIFs are not required to repurchase investors’ shares or units.
The legislation also states that while an AIFM authorised to market units or shares of AIFs to retail investors in a particular member state must offer facilities locally to investors to make subscriptions or payments and to repurchase or redeem shares or units, they do not need to establish a physical presence there but can use electronic or other distance communication.