It's been a few years since implementation of the AIFMD and the times when barely any regulatory update would not mention distribution of investment funds. Has the industry got to grips with the requirements? How have those who establish and market funds from the UK adapted to the rules? How are they dealing with the differing demands of the AIFMD and FSMA? In this article, written for and originally published in Compliance Monitor (and updated in March 2019), Emma Radmore and Barry Stimpson of Womble Bond Dickinson (UK) LLP outline the key regulatory considerations and the practicalities of a marketing strategy.
Is it a duck?
The first, and critical, thing to do is to correctly categorise your vehicle. For the purposes of English law, there are two key questions:
- Is it a collective investment scheme (CIS); and
- Is it an alternative investment fund (AIF).
We always look at the CIS question first.
S235 FSMA defines a CIS as "arrangements with respect to property of any description, the purpose or effect of which is to enable persons taking part in the arrangements... to participate in or receive the profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income". This wide basic definition is then qualified. In order to be a CIS, the arrangements:
(a) must be such that the participants do not have day-to-day control over the management of the property; and
(b) either (i) the contributions of the participants and the profits or income out of which payments are to be made to them are pooled, and/or (ii) the property is managed as a whole by or on behalf of the operator of the scheme.
In principle, this wide definition will cover virtually any arrangement whereby more than one person puts money in, hoping to receive a profit. It would cover incorporated vehicles, whether open- or closed-ended, limited partnerships and limited liability partnerships, trusts and contractual vehicles.
From this wide starting point, it is then a question of narrowing the scope, either by structuring the arrangements so that they do not meet the conditions in the main definition (typically, this can be done for smaller partnerships by ensuring that all participants do have day-to-day control), or by falling within an exemption in the secondary legislation made under FSMA. There are around 20 exemptions, but a couple are commonly used. The main, and easy to apply, exemption takes all bodies corporate except for OEICs outside the CIS definition. The other common exemption applies where all participants enter into the arrangements for commercial purposes wholly or mainly related to ongoing business. However, this exemption comes with complex conditions and, if just one participant does not meet them, the entire arrangement becomes a CIS.
So, first, determine whether you have a CIS.
Then, determine whether you have an AIF. The criteria to determine whether an arrangement is an AIF are similar, but not identical, to those for a CIS. The key difference that makes the AIF definition broader is that any body corporate can be an AIF. An AIF is defined as "a collective investment undertaking, including investment compartments of such an undertaking, which:- (a) raises capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of these investors; and (b) does not require authorisation pursuant to the UCITS Directive".
Focusing on the first of these (this article doesn't cover marketing of UCITS), the test is one of (i) is the entity a "collective investment undertaking" (CIU) and, if it is, is it (ii) raising capital and (iii) having a defined investment policy. There is much guidance, including for the benefit of UK readers from the FCA, unpicking what these terms mean. Key considerations include that:
- an entity that genuinely has a commercial or industrial purpose will not be a CIU and therefore not an AIF
- an entity in which the unit or shareholders all have day-to-day control will not be a CIU
- an entity that is self-managed can still be an AIF
- it does not matter what the assets the undertaking invests in are
- activity can still count as capital-raising even if it only happens once; and
- having only one investor does not mean a vehicle is not an AIF unless it is prevented from having more than one investor – even then the arrangement may still be an AIF if the single investor invests on behalf of a number of others.
If an arrangement is a CIS, it will invariably also be an AIF, and there will be many vehicles which are AIFs but not CIS.
What if it is a duck? (in the form of an AIF)
The purpose of this article is not to consider which regulated activities (for FSMA) purposes might be carried on in relation to the CIS and/or AIF, but suffice it to say that any person who establishes, operates, manages, sub-manages or advises in relation to such a vehicle needs to have considered their regulatory position.
This article, though, is focusing on the marketing of the vehicles. And here we have to look at several variants, each asking the key questions:
- Who is doing the marketing?
- Who are they marketing to?
- Is the vehicle a CIS?
- What form does the marketing take?
UK authorised firm
A UK authorised firm must, in principle comply with the financial promotion restrictions in s21 FSMA. If, however, the vehicle in question is an EU-incorporated AIF (except if it is an EU-incorporated feeder fund of a non-EEA AIF), and is being marketed only to professional investors, the AIFMD requires that an AIFM authorised under the AIFMD, or an authorised investment firm or other person acting at the initiative or on behalf of the AIFM may make "any direct or indirect offering or placement" of interests in the AIF with FCA approval in line with a relatively simple notification process.
- The UK concept of "financial promotion" goes significantly wider than the AIFMD concept of "marketing" – and as a result the financial promotion restrictions will often kick in at an earlier stage than "marketing" begins
- This regime covers only EEA AIFs; and
- Where the promotion is to any person other than a "professional" investor for MiFID purposes, then the AIFMD does not apply in any event.
As a result, UK firms targeting UK investors will need to be aware of the financial promotion restriction, the relevant exemptions in, respectively, the FSMA (Financial Promotion) Order (FPO) and the FSMA (Promotion of CIS)(Exemptions) Order (CISPO) as well as FCA's Conduct of Business Sourcebook (COBS) rules. The way in which these come into play will depend largely on whether the AIF is also a CIS. If it is, its marketing is limited by CISPO and COBS even for authorised firms. For instance, it is practically difficult or impossible to promote to a UK retail investor a CIS which has as its underlying investment anything other than shares or debt securities in an unlisted company.
EEA-authorised firms are in a similar position to UK firms – subject to having the correct passports to do business in the UK. UK firms wishing to market to retail investors elsewhere in the EEA, or to conduct activities which are not AIFMD "marketing" will need to consider the local equivalents of the FSMA restrictions.
Where the AIF is a third-country AIF, instead of the "passport" for marketing, each EU Member State may allow EU AIFMs to market non-EEA AIFs to professional investors based on a notification to the regulator provided they comply with certain requirements:
- The AIFM must comply with key AIFMD depository and custody requirements
- There is a co-operation agreement in place between the AIFM's regulator and the regulator in the jurisdiction of the AIF; and
- The AIF is not established in a territory the Financial Action Task Force has designated as non-cooperative.
But again, the more stringent national provisions apply for any activity other than marketing.
Third country firm
Non-EEA AIFMs marketing non-EEA AIFs may, again, market in any given Member State on the basis of a notification only if the Member State has chosen to allow marketing to professional investors on the basis of compliance with:
- The AIFMD's transparency rules in respect of each AIF and if applicable rules on acquiring control of non-listed entities
- The co-operation agreements and FATF status requirements outlined above.
The same observations as above also apply to any activities outside this narrow scope.
Getting your ducks in a row?
So, at present, unless you are an EEA authorised entity doing nothing other than "marketing" for AIFMD purposes an EEA AIF to professional investors only, you can't align your ducks. The vagaries of each individual Member State's laws will affect your strategy to a greater or lesser extent, making a pan-European marketing programme time-consuming and costly to achieve, with some Member States putting in place significant barriers.
Are changes afoot?
As we've explained, even where only professional investors are targeted from within the EU, the AIFMD has not been an outstanding success, and the European Commission has proposed some changes in the form of a draft Directive and Regulation for the marketing of both AIFs and UCITS.
One major challenge has been the narrow definition of "marketing". As noted above, because this defined activity kicks in relatively late in the selling process, anything that goes before it ("pre-marketing") is at the whim of national laws. Some take a very permissive view, others very restrictive. Very rarely would a marketing campaign begin with what AIFMD classes as "marketing" and as a result, firms cannot devise a simple strategy based on AIFMD compliance – they need to seek local advice even when marketing an EEA-based fund only to professionals. When they are marketing a non-EEA based fund, there is no single solution, given the continuing absence of any declarations of "equivalence" of third country regimes by ESMA.
The industry has not been silent on the difficulties the AIFMD has caused those wishing to market funds in more than one EEA jurisdiction. The Commission asked for feedback on barriers to marketing back in 2016. As a result, the Commission produced, in March, a proposal on the cross-border distribution of investment funds. The proposal covers both AIFs and UCITS and aims to harmonise the definition of "marketing". The Commission claims the proposals will improve transparency and remove overly burdensome requirements, all as part of the CMU plan.
On the transparency side of things, a proposed Regulation would require:
- Marketing communications to be identifiable as such with equal presentation of risks and rewards and should explain how potential investors can get a summary of their rights by providing a hyperlink which would also include details of redress mechanisms
- All national regulators to publish online all requirements relevant to the marketing of AIFs or UCITS and ESMA to keep a central database of these, as well as of all AIFMs, UCITS managers, AIFs and UCITS
- That any approvals of marketing communications required by competent authorities (which can apply to marketing UCITS, or to AIFMs, EuSEF and EuVECA managers marketing to retail investors) be given within 10 days and any charges levied by authorities must be proportionate; and
- That EuVECA and EuSEF managers should be able to target investors to test their appetite for investment through pre-marketing.
The proposed Directive would amend both the UCITS Directive and AIFMD. The AIFMD-related changes would:
- Permit "pre-marketing" for which Member States are not allowed to impose notification requirements but which is only narrowly defined (and discussed below) and only to professional investors
- Permit AIFMs to discontinue marketing if there are investors holding only up to 5% of the AIF's AUM in the relevant Member State and
- Require Member States who allow marketing of AIFs to retail investors to treat those investors consistently.
By defining "marketing", the proposal attempts to clarify what activities constitute "pre-marketing" and therefore will not require firms to apply for the AIFMD passport in order to conduct them. Under the original proposal, a firm would be considered to be "pre-marketing" only where both the fund is not yet in existence and no offering, constitutional or subscription documents, even in draft form, are distributed. This would mean that anything done once the fund exists or an indicative red herring information memorandum is made available will now fall within the definition of "marketing" – whereas in many member states this would not currently be considered marketing.
This suggestion caused concern in the market as it appeared to create more problems than it would have solved. There was relief when the EU Council published a revised proposal, which more closely tracked the current view of the FCA – and would allow AIFMs to sound out prospective investors without the need for notification so long as the investors are professional investors and the documentation has not been finalised, it is clear that the documentation that exists is incomplete and does not constitute an offer, and therefore investors cannot at that point subscribe.
If this proposal goes through, it should both allow the more permissive jurisdictions to carry on business as usual, while forcing those that have applied a harsher test to relax the boundaries.
The Council has, however, put in a further provision that would restrict the use of the reverse solicitation exemption. It proposes that any subscription that comes within 18 months of pre-marketing of an AIF (whether by name or not) will be regarded as marketing and therefore subject to notification or authorisation. To better control this, the European Parliament suggested an information notification to relevant regulators mentioning the intention to pre-market, and that AIFMs keep appropriate records of what they do, so they can make details available to regulators on request.
In any event, of course, third country AIFMs are unaffected by these changes.
The Council and Parliament reached provisional agreement on the Directive in Febuary 2019, and a plenary vote in Parliament is scheduled for 15 April.
Member States will not be implementing any changes until well after Brexit. Depending on the final terms of Brexit, then, the UK will implement the changes, or something close to them, or not.
In the meantime, those wishing to market AIFs to European investors will continue to have to take account of the myriad local regulatory requirements just as they do when marketing in third countries.