Weighing up your options
21 Mar 2019
Derbhil O’Riordan of Dillon Eustace discusses marketing investment funds in the EU as a third country manager
Image: Shutterstock
The EU is a key target market for sales of investment funds.
For those seeking to sell investment funds in the EU, three different investment fund regimes exist:
The UCITS regime: This regime relates to EU UCITS funds. UCITS are permitted to be sold on a cross-border basis in the EU. As the marketing passport for a UCITS attaches to the UCITS itself and not its manager, we have not considered further the marketing of UCITS in the EU by third country managers.
The Alternative Investment Fund Managers Directive regime (AIFMD regime): This regime applies to the EU single market and relates to alternative investment fund managers (AIFMs) managing alternative investment funds (including private equity and hedge funds) (AIFs) within the EU.
National private placement rules (NPPR): This regime imposes rules at EU level for selling non-EU funds in the EU but also allows individual member states to impose their own requirements on any sale within their own border.
In this article, we will briefly look at the AIFMD and NPPR regimes as they currently co-exist, and how they are accessed by non-EU managers.
AIFMD regime
AIFMD creates a single marketplace within the EU for the marketing of AIFs, known as a marketing passport. Under the AIFMD, the activity of marketing includes “any direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM, of units or shares in a fund it manages to or with investors domiciled in the EU”.
This definition does not include reverse solicitation, which should be considered to be outside the scope of the AIFMD and is not considered in this article. In addition to managers based in the EU, the AIFMD applies to any non-EU based fund manager (including, for example, fund managers based in the UK (post-Brexit), US or Asia) that:
Manages one or more AIFs domiciled in the EU; and/or
Markets AIFs to investors in the EU (irrespective of the AIF’s domicile)
For example, a US-based fund manager managing Cayman-based offshore funds that are marketed to EU investors in a master-feeder structure would typically fall within the scope of the AIFMD.
At the time of writing, only entities established in the EU can be authorised as AIFMs to obtain the marketing passport for their EU domiciled AIFs.
However, European Securities and Markets Authority (ESMA) and the European Commission are currently analysing the suitability of a number of non-EU jurisdictions (separately, on a case-by-case basis) with a view to deciding whether they will decide to “switch on” certain provisions of the AIFMD for those jurisdictions.
Where the relevant provisions of AIFMD are “switched on” in respect of a given jurisdiction, non-EU based managers based in the relevant jurisdiction will be permitted to apply to become authorised as an AIFM under the AIFM Directive and market its funds in the EU under the marketing passport. However, for the time being, managers based outside the EU (being “third country” managers) can continue to market in an EU member state without the marketing passport, provided the marketing is subject to:
The EU member state’s own NPPRs
Transparency rules imposed by the AIFMD
EU-based AIFMs with AIFs inside the EU: notification procedure
Under AIFMD, subject to a straightforward notification process, EU-authorised AIFMs have a passport to freely market EU-domiciled AIFs to professional investors—that is, investors considered to be professional clients or treated as professional clients on request, within the second Markets in Financial Instruments Directive (MiFID II)—in both its own member state and other EU member states.
Once the AIFM is authorised in one EU member state, it does not require further authorisation in any other EU member state to market its EU AIFs to professional investors in other member states. Unlike UCITS, the passport does not attach to the AIF and is instead granted to the AIFM.
An AIFM established in an EU member state and authorised by the competent regulatory authority in that member state has the right under the AIFMD to both:
Market shares of an EU AIF that it manages to professional investors in the AIFM’s home member state (subject to providing a prescribed Notification File to its home EU member state regulator).
Market shares of an EU AIF that it manages to professional investors in another EU member state—subject to providing a prescribed Notification File to its home EU member state regulator.
The home EU member state regulator can only prevent the marketing of shares in EU AIFs if the information in the notification shows that the AIF concerned will not be managed in accordance with the AIFMD.
EU-based AIFMs with AIFs outside the EU: notification procedure
Under the AIFMD, each EU member state can allow an authorised EU AIFM to market a non-EU AIF to professional investors in that EU member state under that EU member state’s own NPPRs, without a passport, provided:
The AIFM complies with basic depositary and custody requirements under the AIFMD (such as the safekeeping of assets and the supervision of administrative functions).
There is a co-operation arrangement for the purpose of systemic risk oversight between the regulator of the AIFM’s home member state and the supervisory authority of the non-EU country where the AIF is established.
The non-EU country where the AIF is established is not listed as a non-co-operative country and territory by the Financial Action Task Force on anti-money laundering and terrorist financing.
As mentioned above, it is envisaged that certain provisions of the AIFMD will be ‘switched on’ in order to allow for EU AIFMs to apply for a passport for their non-EU AIFs, depending on the jurisdiction in which they are established.
The AIFMD also envisages that three years after the European passport becomes available to EU AIFMs of non-EU AIFs, ESMA will issue a further opinion on the continuation of the NPPR regime in the EU.
Subject to the provisions of this advice, it is envisaged that:
The EU will adopt rules to terminate the NPPRs as a means of access to the EU
The European passport will become the sole and mandatory regime applicable in all member states
AIFMs based outside the EU with AIFs based outside the EU: notification procedure
Under the AIFMD, each EU member state can allow non-EU AIFMs to market a non-EU AIF to professional investors in that member state under that member state’s own NPPRs (that is, without a passport) provided:
The AIFM complies with the transparency rules in respect of each AIF marketed by the AIFM and (where applicable) with certain additional rules relating to acquiring control of non-listed entities
There is a co-operation arrangement for the purpose of systemic risk oversight between the regulator of the EU member state where the AIF is marketed, the supervisory authorities of the non-EU country where the non-EU AIFM is established and the supervisory authority of the third country where the AIF is established
The non-EU country where the AIF is established is not listed as a non-co-operative country and territory by the Financial Action Task Force
The advice from ESMA being issued on a country-by-country basis in respect of the extension of the EU passport to EU AIFMs of non-EU AIFs are also envisaged to cover non-EU AIFMS and their non-EU AIFs. Subject to the provisions of this advice, it is envisaged that certain provisions of the AIFM Directive will then be “switched on” to allow for non-EU AIFMs to apply for authorisation under the Directive, enabling them access to a European passport.
The transparency rules
The transparency rules impose specific obligations on AIFMs applicable to AIFs marketed in the EU, including annual report disclosure requirements, disclosure to investors, and periodic reporting to competent authorities.
National private placement rules
Under the AIFMD, member states have discretion (to allow for the marketing of non-EU AIFs marketed by EU AIFMs and AIFs marketed by non-EU AIFMs on a private placement basis.
Countries that intend to allow private placement must apply the minimum AIFMD standards to AIFMs marketing under the regime. In addition to the standard AIFMD requirements, each EU member state can impose its own additional NPPRs in relation to the marketing of the product.
If an investment fund intends to access an EU market through private placement, the fund manager should be familiar and compliant with the relevant NPPRs of the member state. In addition, considering the broad level of discretion given to individual member states and the wide variety of applicable rules in each jurisdiction, the fund manager should consult legal counsel in the relevant member state before approaching investors.
An overview of the NPPRs for each EU member state is outside the scope of this article. Managers should note that it is necessary to obtain advice on a jurisdiction-by-jurisdiction basis before sell in the EU under the NPPRs.
UK and Brexit
On the UK’s exit from the EU, the UK will no longer (subject to the outcome of the negotiations with the EU) have the benefit of AIFMD.
Therefore, the UK can lose certain rights that EU managers and AIFMs currently have. For example, in terms of managing EU AIFs, a UK AIFM will most likely have the same rights as a US AIFM.
However, a UK AIFM could no longer market its EU-domiciled AIFs cross-border within the EU.
Although similar to a US AIFM, a UK AIFM could act as investment manager to Irish funds and so continue its management activities, the cross-border distribution will most certainly be affected. UK managers that see the EU (even if only a few EU countries) as their target distribution base will need to ensure that they keep a foothold in the EU before enjoying the benefits of EU-regulated entities in the financial services industry.
The available options for UK managers include:
Setting up an AIFM or Super ManCo (that is, a regulated entity that can manage and market both UCITS and AIFs) in another EU member state (such as Ireland or Luxembourg)
Using a third-party AIFM established in another EU member state
Putting their fund on a third party platform that is already established in another EU member state
Although the second and third options certainly benefit from economies of scale (both in terms of start-up and ongoing maintenance costs), they should both be considered carefully in terms of practical distribution issues and future business growth.
Conclusion
Before setting out to market an investment fund in the EU, managers of investment funds should consider the three regimes currently in force and weigh up the benefits and costs of each.
Given the strict rules around marketing in the EU, the choice of the regime should be made before approaching investors.
Both the UCITS and AIFM Directive regimes now offer an EU passport.
However, for funds (or AIFs) that cannot fit within those regimes, the EU will remain a patchwork of regulation which must be navigated carefully with the assistance of local counsel in each relevant jurisdiction.
As has always been the case, for those selling in the EU without the benefit of an EU passport, the legal requirements of certain jurisdictions will remain easier to navigate than others.
For those seeking to sell investment funds in the EU, three different investment fund regimes exist:
The UCITS regime: This regime relates to EU UCITS funds. UCITS are permitted to be sold on a cross-border basis in the EU. As the marketing passport for a UCITS attaches to the UCITS itself and not its manager, we have not considered further the marketing of UCITS in the EU by third country managers.
The Alternative Investment Fund Managers Directive regime (AIFMD regime): This regime applies to the EU single market and relates to alternative investment fund managers (AIFMs) managing alternative investment funds (including private equity and hedge funds) (AIFs) within the EU.
National private placement rules (NPPR): This regime imposes rules at EU level for selling non-EU funds in the EU but also allows individual member states to impose their own requirements on any sale within their own border.
In this article, we will briefly look at the AIFMD and NPPR regimes as they currently co-exist, and how they are accessed by non-EU managers.
AIFMD regime
AIFMD creates a single marketplace within the EU for the marketing of AIFs, known as a marketing passport. Under the AIFMD, the activity of marketing includes “any direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM, of units or shares in a fund it manages to or with investors domiciled in the EU”.
This definition does not include reverse solicitation, which should be considered to be outside the scope of the AIFMD and is not considered in this article. In addition to managers based in the EU, the AIFMD applies to any non-EU based fund manager (including, for example, fund managers based in the UK (post-Brexit), US or Asia) that:
Manages one or more AIFs domiciled in the EU; and/or
Markets AIFs to investors in the EU (irrespective of the AIF’s domicile)
For example, a US-based fund manager managing Cayman-based offshore funds that are marketed to EU investors in a master-feeder structure would typically fall within the scope of the AIFMD.
At the time of writing, only entities established in the EU can be authorised as AIFMs to obtain the marketing passport for their EU domiciled AIFs.
However, European Securities and Markets Authority (ESMA) and the European Commission are currently analysing the suitability of a number of non-EU jurisdictions (separately, on a case-by-case basis) with a view to deciding whether they will decide to “switch on” certain provisions of the AIFMD for those jurisdictions.
Where the relevant provisions of AIFMD are “switched on” in respect of a given jurisdiction, non-EU based managers based in the relevant jurisdiction will be permitted to apply to become authorised as an AIFM under the AIFM Directive and market its funds in the EU under the marketing passport. However, for the time being, managers based outside the EU (being “third country” managers) can continue to market in an EU member state without the marketing passport, provided the marketing is subject to:
The EU member state’s own NPPRs
Transparency rules imposed by the AIFMD
EU-based AIFMs with AIFs inside the EU: notification procedure
Under AIFMD, subject to a straightforward notification process, EU-authorised AIFMs have a passport to freely market EU-domiciled AIFs to professional investors—that is, investors considered to be professional clients or treated as professional clients on request, within the second Markets in Financial Instruments Directive (MiFID II)—in both its own member state and other EU member states.
Once the AIFM is authorised in one EU member state, it does not require further authorisation in any other EU member state to market its EU AIFs to professional investors in other member states. Unlike UCITS, the passport does not attach to the AIF and is instead granted to the AIFM.
An AIFM established in an EU member state and authorised by the competent regulatory authority in that member state has the right under the AIFMD to both:
Market shares of an EU AIF that it manages to professional investors in the AIFM’s home member state (subject to providing a prescribed Notification File to its home EU member state regulator).
Market shares of an EU AIF that it manages to professional investors in another EU member state—subject to providing a prescribed Notification File to its home EU member state regulator.
The home EU member state regulator can only prevent the marketing of shares in EU AIFs if the information in the notification shows that the AIF concerned will not be managed in accordance with the AIFMD.
EU-based AIFMs with AIFs outside the EU: notification procedure
Under the AIFMD, each EU member state can allow an authorised EU AIFM to market a non-EU AIF to professional investors in that EU member state under that EU member state’s own NPPRs, without a passport, provided:
The AIFM complies with basic depositary and custody requirements under the AIFMD (such as the safekeeping of assets and the supervision of administrative functions).
There is a co-operation arrangement for the purpose of systemic risk oversight between the regulator of the AIFM’s home member state and the supervisory authority of the non-EU country where the AIF is established.
The non-EU country where the AIF is established is not listed as a non-co-operative country and territory by the Financial Action Task Force on anti-money laundering and terrorist financing.
As mentioned above, it is envisaged that certain provisions of the AIFMD will be ‘switched on’ in order to allow for EU AIFMs to apply for a passport for their non-EU AIFs, depending on the jurisdiction in which they are established.
The AIFMD also envisages that three years after the European passport becomes available to EU AIFMs of non-EU AIFs, ESMA will issue a further opinion on the continuation of the NPPR regime in the EU.
Subject to the provisions of this advice, it is envisaged that:
The EU will adopt rules to terminate the NPPRs as a means of access to the EU
The European passport will become the sole and mandatory regime applicable in all member states
AIFMs based outside the EU with AIFs based outside the EU: notification procedure
Under the AIFMD, each EU member state can allow non-EU AIFMs to market a non-EU AIF to professional investors in that member state under that member state’s own NPPRs (that is, without a passport) provided:
The AIFM complies with the transparency rules in respect of each AIF marketed by the AIFM and (where applicable) with certain additional rules relating to acquiring control of non-listed entities
There is a co-operation arrangement for the purpose of systemic risk oversight between the regulator of the EU member state where the AIF is marketed, the supervisory authorities of the non-EU country where the non-EU AIFM is established and the supervisory authority of the third country where the AIF is established
The non-EU country where the AIF is established is not listed as a non-co-operative country and territory by the Financial Action Task Force
The advice from ESMA being issued on a country-by-country basis in respect of the extension of the EU passport to EU AIFMs of non-EU AIFs are also envisaged to cover non-EU AIFMS and their non-EU AIFs. Subject to the provisions of this advice, it is envisaged that certain provisions of the AIFM Directive will then be “switched on” to allow for non-EU AIFMs to apply for authorisation under the Directive, enabling them access to a European passport.
The transparency rules
The transparency rules impose specific obligations on AIFMs applicable to AIFs marketed in the EU, including annual report disclosure requirements, disclosure to investors, and periodic reporting to competent authorities.
National private placement rules
Under the AIFMD, member states have discretion (to allow for the marketing of non-EU AIFs marketed by EU AIFMs and AIFs marketed by non-EU AIFMs on a private placement basis.
Countries that intend to allow private placement must apply the minimum AIFMD standards to AIFMs marketing under the regime. In addition to the standard AIFMD requirements, each EU member state can impose its own additional NPPRs in relation to the marketing of the product.
If an investment fund intends to access an EU market through private placement, the fund manager should be familiar and compliant with the relevant NPPRs of the member state. In addition, considering the broad level of discretion given to individual member states and the wide variety of applicable rules in each jurisdiction, the fund manager should consult legal counsel in the relevant member state before approaching investors.
An overview of the NPPRs for each EU member state is outside the scope of this article. Managers should note that it is necessary to obtain advice on a jurisdiction-by-jurisdiction basis before sell in the EU under the NPPRs.
UK and Brexit
On the UK’s exit from the EU, the UK will no longer (subject to the outcome of the negotiations with the EU) have the benefit of AIFMD.
Therefore, the UK can lose certain rights that EU managers and AIFMs currently have. For example, in terms of managing EU AIFs, a UK AIFM will most likely have the same rights as a US AIFM.
However, a UK AIFM could no longer market its EU-domiciled AIFs cross-border within the EU.
Although similar to a US AIFM, a UK AIFM could act as investment manager to Irish funds and so continue its management activities, the cross-border distribution will most certainly be affected. UK managers that see the EU (even if only a few EU countries) as their target distribution base will need to ensure that they keep a foothold in the EU before enjoying the benefits of EU-regulated entities in the financial services industry.
The available options for UK managers include:
Setting up an AIFM or Super ManCo (that is, a regulated entity that can manage and market both UCITS and AIFs) in another EU member state (such as Ireland or Luxembourg)
Using a third-party AIFM established in another EU member state
Putting their fund on a third party platform that is already established in another EU member state
Although the second and third options certainly benefit from economies of scale (both in terms of start-up and ongoing maintenance costs), they should both be considered carefully in terms of practical distribution issues and future business growth.
Conclusion
Before setting out to market an investment fund in the EU, managers of investment funds should consider the three regimes currently in force and weigh up the benefits and costs of each.
Given the strict rules around marketing in the EU, the choice of the regime should be made before approaching investors.
Both the UCITS and AIFM Directive regimes now offer an EU passport.
However, for funds (or AIFs) that cannot fit within those regimes, the EU will remain a patchwork of regulation which must be navigated carefully with the assistance of local counsel in each relevant jurisdiction.
As has always been the case, for those selling in the EU without the benefit of an EU passport, the legal requirements of certain jurisdictions will remain easier to navigate than others.
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