In advance of the deadline for its transposition into national EU Member State law on July 21, 2013, the Alternative Investment Fund Managers Directive (the “Directive”) has been the subject of recent implementing measures at both the EU and individual EU Member State level and guidance from the European Securities and Markets Authority (“ESMA”) and other EU Member State governmental authorities.
This Client Alert provides a short update to our previous November 2010 Client Alert on the Directive and is intended to provide a summary guide to non-EU based fund managers as to the practical steps that they need to undertake now so as to assist with compliance with the new regulatory regime with a particular focus on marketing.
Defined terms used in this Client Alert have the meanings given in our previous Client Alert and in particular “non-EU AIFM” refers to a non-EU based alternative investment fund manager and “EU AIFM” refers to its EU based counterpart, as defined under the Directive. “AIF” refers to an alternative investment fund as defined under the Directive.
Summary of the Directive and its Effect on Non-EU AIFMs
The broad intent behind the Directive is to provide a harmonised regime for the regulation of alternative investment fund managers in the EU and to “fill the European regulatory gap” alongside UCITS and MIFID – the other core European directives with effect on investment funds and other investment products. Leaving aside whether this intent will be met by the Directive, the Directive will undoubtedly be of significance to a wide variety of non-UCITS managers operating across a spectrum of asset classes including: venture capital, private equity, private equity real estate, infrastructure, hedge and other alternatives.
The Directive provides for an extensive set of rules governing the authorisation of AIFMs and includes certain organisational requirements (including governance, capital requirements, delegation, depositary functions, etc.) together with other continuing obligations on AIFMs in relation to the AIFs they manage (such as leverage limitations and general fund and specific private equity reporting and disclosure obligations). The immediate impact of the Directive in relation to non-EU AIFMs will be in relation to the steps required in order for such managers to manage EU-based investment funds and/or market the interests of non-EU AIFs to European based professional investors.
As we mentioned in our previous Client Alert, the Directive will operate a dual approach to marketing in the interim stages of its implementation with national private placement rules operating alongside a more formal passport procedure (note that the passport procedure will only be available to non-EU AIFMs from late 2015 at the earliest).
In practice, we anticipate that many non-EU AIFMs without EU based platforms will continue to market their products to EU investors under European private placement regimes until the implications and costs of complying with the more extensive EU passport regime become clearer.
Key Dates in the Development of the Directive
The following timeline illustrates the key dates regarding the implementation of the Directive and marketing under the Directive.
Click here to view diagram.
The Directive came into force on July 21, 2011 and is required to be transposed into the national law of each EU Member State by July 22, 2013. The “Level 2” regulation supplementing the Directive with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision was published in the Official Journal of the EU on March 22, 2013 and will also apply from July 22, 2013.
Key Immediate Steps for Non-EU AIFMs
In relation to fund marketing from now through July 21, 2013, non-EU AIFMs will need to undertake the following recommended steps:
- Determine whether the Directive is (or will be) of effect to them or whether they can avail themselves of any of the exemptions (see following section).
- Confirm how the Directive has been (or will be) implemented by each EU Member State in which the AIFM intends to market its AIF(s) and in particular, whether steps have been taken by that EU Member State to restrict existing private placement rules.
- Develop a fund structure which meets the requirements of the Directive as well as the international tax and other regulatory requirements of the AIFM and fund investors.
- Confirm that the competent authorities of the jurisdiction(s) of the non-EU AIF and the non-AIFM have entered into co-operation agreements with the relevant regulators of the EU Member States in which marketing is to occur. Confirmations should also be sought that the jurisdiction(s) of the proposed non-EU AIF/AIFM also meet the requirements of the Financial Action Task Force in relation to anti-money laundering.
- Investigate whether marketing can be structured to take advantage of the rules surrounding passive marketing.
- The AIF’s offering memorandum and/or private placement memorandum should be reviewed to confirm that it is in compliance with the necessary disclosures of the Directive.
- The AIFM should develop systems to provide requisite reporting/disclosure to both EU investors and regulatory authorities in the EU Member States in which those investors are based.
- If applicable, procedures should be put in place to ensure compliance with the private equity specific reporting and disclosure obligations.
Non-EU based fund managers that have an EU Member State presence, such as a subsidiary or affiliate in an EU Member State, will need to determine whether the services carried out from that presence amount to services which constitute it as an AIFM under the Directive. In the event that the functions of that EU presence do constitute an AIFM under the Directive, there will then be a requirement for the EU-based platform to become authorised under the Directive. Alternatively, steps can be taken to minimise the EU presence of the fund manager to avoid the requirement for authorisation.
Non-EU AIFMs which manage or intend to manage EU AIFs will need to ascertain whether they will need to become authorised under the Directive. It is likely that a non-EU AIFM managing EU AIFs will need to become authorised under the Directive in the latter part of 2015.
Useful Exemptions Under the Directive
There are a number of exemptions/partial exemptions which are relevant to non-EU AIFMs under the Directive:
Partial exemption for AIFM managing small AIFs: There are partial exemptions for AIFMs managing small AIFs with assets under management which do not exceed either: (i) €500m (provided the AIFs are not leveraged and investors have no redemption rights in the first five years i.e. classic private equity funds); or (ii) €100m (including assets acquired through the use of leverage).
To determine if the exemption applies, the AIFM has to aggregate all the AIFs which it manages. An AIFM relying on this exemption will be subject to registration and limited regulatory reporting requirements; however, EU member states will have discretion to impose stricter requirements.
Exemption regarding certain closed-ended AIFs in run-off or with a limited life: There is an exemption available for AIFMs managing certain closed-end funds which either: (i) are in run-off (i.e. are making no further investments after July 22, 2013); or (ii) have a limited life which expires by July 22, 2016 and whose subscription period ended before July 21, 2011. Note that an AIF with a limited life span falling within point (ii) will need to produce annual reports for its AIFs and comply with the private equity specific reporting/disclosure requirements.
Other Entities: Specifically excluded from the definition of an AIF are holding companies, joint ventures, securitisation special purpose entities, pension funds, employee participation or savings schemes and family offices, meaning that if a fund manager only operates these types of entity, they will likely be exempt.
Implications for Fundraising in the EU by Non-EU AIFMs Beginning July 22, 2013
The broad effect of the Directive means that beginning July 22, 2013, it will be of application to any AIFM that markets an AIF to professional investors in EU Member States (and is not able to avail itself of an exemption).
The use of intermediaries to market an AIF to EU investors will not take the AIFM outside the scope of the Directive. However, reverse solicitation (i.e. situations where the investor approaches the AIF and/or the AIFM with a view to investing in the AIF) falls outside of the remit of the Directive. This means that a non-EU AIF may fall outside of the scope of the Directive if all EU investors have invested on the basis of reverse solicitation. Reverse solicitation will, however, need to be approached with caution by managers as guidance on what actually constitutes reverse solicitation under the Directive is limited and the concept is subject to narrow application by most regulatory authorities under existing rules.
Continued Reliance on Private Placement Rules
It is not anticipated that non-EU AIFMs will need to be fully authorised under the Directive to market their AIFs in the EU until at least July 2018 (when it is envisaged that private placement regimes will terminate and the only marketing that will be possible will be pursuant to the passport regime). Until that time, it is anticipated that non-EU AIFMs will continue to market to EU professional investors by way of local private placement regimes (which may well be subject to amendment in individual EU Member States), subject to also meeting the following minimum conditions:
- The non-EU AIFM complies with the reporting and disclosure obligations under the Directive for each AIF marketed in the EU. These obligations consist of certain pre-investment (for the purposes of any offering memorandum or private placement memorandum) and on-going disclosures to investors, an annual report and regular reports to EU Member State regulators.
- Appropriate cooperation agreements exist between the national regulator of each EU Member State in which marketing takes place and the supervisory authorities of the jurisdiction where the non-EU AIF/AIFM is established. We anticipate that funds established in the U.S, the Cayman Islands, Jersey and Guernsey will meet this requirement and ESMA is currently negotiating with the relevant authorities in such jurisdictions on behalf of EU Member States.
- The countries where the non-EU AIF/AIFM are established must not be on the list of non-cooperative countries and territories maintained by the Financial Action Task Force.
- If the non-EU AIFM manages an AIF which makes investments in an unlisted company with a registered office in the EU, the non-EU AIFM will need to ensure compliance with the private equity disclosure and reporting obligations.
Provided the above conditions are met, the non-EU AIFM may, subject to the terms of the applicable national private placement rules, market and raise capital from EU based professional investors. As individual EU member states can impose additional requirements and conditions under their national private placement regimes, a country-by-country analysis will remain necessary in any marketing exercise. Certain countries (notably Germany) are already taking steps to limit the application of their private placement regimes.
Passport Regime for Non-EU AIFMs from 2015
It is anticipated that beginning September 2015, non-EU AIFMs will be able to avail themselves of a passport (as an alternative to the private placement mechanism) to market on a pan-European basis. However, to do so, such AIFMs will need to ensure full compliance with and authorisation under the Directive (including provisions relating to regulatory capital, depositaries and remuneration).
With the transposition of the Directive only a few months away, it is essential that non-EU AIFMs ensure that they are aware of and have procedures in place to deal with the impact of the Directive. The key immediate steps listed above should be a basic starting point for any non-EU based manager.
As to fundraising, it is important for any non-EU based manager to look at both its own fund management business and intended fund investors holistically. The Directive is likely to have a significant effect on fund structures going forward and the earlier these issues are considered in the fundraising process, the more efficient the outcome is likely to be for both the fund sponsor and investors alike in devising an effective fund structure which meets the requirements of investors and regulators but not at unnecessary cost.