23rd February 2021
In light of the UK’s departure from the European Union, there has been increased scrutiny on the regulatory permissions for third countries undertaking the activity of marketing to EU based investors. Here we aim to set out the potential routes by which distribution to EU investors may be undertaken.
It is likely that these discussions will continue to evolve in the coming months as the financial services industry settles on an optimum solution. In the meantime, UK fund sponsors are evaluating their options against an uncertain backdrop because of: (a) the newness of this issue for them; (b) the potential further negotiations between the UK and EU on what equivalence means in the Brexit agreement; and (c) the ongoing political landscape between the EU and the UK which may influence practices and regulations implemented by regulators.
Brexit has not changed the legal position for non-EU firms in relation to the activity of marketing financial products in the European Union. However, for UK based financial services firms who have traditionally relied on their ability to market in the EU on the basis of the MiFID passport, the loss of regulatory cover now requires careful consideration.
Non-EU managers that have traditionally relied on UK based personnel to market their funds in Europe are also affected, and this includes placement agents as well as in-house teams. The political agenda surrounding Brexit means that there is more scrutiny by the European Securities and Markets Authority and the EU on the UK as a third country, which in turn affects all third country managers, including those in North America and Asia.
Broadly then, we see several potential solutions that a fund sponsor may wish to consider when marketing in the EU to ensure compliance with the relevant regulations:
(i) Engaging an EU-domiciled, MiFID regulated placement agent;
This is an obvious solution, and most UK based placement agents have resolved their own Brexit issue by either ensuring they (through an EU entity) are themselves registered under MiFID in the EU, or have status as a tied agent (see (v) below) to be able to market in the EU jurisdictions.
(ii) Having a director of the General Partner (only for limited partnership structures) undertake the marketing activities;
This is by no means a straightforward solution. However, there are grounds for arguing that the marketing activity undertaken by a director of the General Partner in relation to the partnership they are managing as a director is not a third-party service, and therefore not captured under MiFID. Care should be taken in relation to evidencing the delineation of boundaries in practice when marketing is undertaken in their capacity as a director of the General Partner, or as an employee of the third country entity. In the UK, where there is a concept of financial promotion which is a regulated activity, this is unlikely to be acceptable. However, this is not the case in most EU countries which do not define that specific regulated activity.
(iii) Secondment of a non-EU based personnel to the EU domiciled AIFM managing the fund, or an EU domiciled MiFID firm with appropriate permissions to undertake marketing;
This is still a viable route but is under scrutiny. Some regulators have indicated that secondments must be approved by them on a case-by-case basis, and they are looking for robust oversight, risk and control frameworks for the employee, ensuring there is no conflict of interest in the role they are playing. In the case of the CSSF in Luxembourg, they have specifically highlighted the requirement to have a physical presence in the premises of the EU authorised entity, it being understood that travels for professional purposes are accepted. Given that a seconded employee whose main role is to market a Fund would be expected to spend a significant amount of time out of the office meeting potential investors, it is yet to be determined how this is required to play out in practice. This is further complicated in the current situation where the covid-19 pandemic has prevented all but the most necessary cross border travel.
(iv) Engaging the host AIFM managing the fund to undertake the marketing activity;
This is similar in principle to the secondment model, in that the regulator will be looking for the same robust oversight, risk and control frameworks for the marketing initiatives, but instead of using a seconded employee, marketing is undertaken by an employee of the EU authorised entity itself. The third country fund sponsor can and will be expected to provide support in the marketing initiatives without breaching the parameters of the operational framework implemented by the host AIFM. The host AIFM will take control of the compliance and risk management of the marketing initiatives, whilst relying on the fund sponsor’s expertise for any commercial considerations and/or insights with respect to the potential investors that they may have greater knowledge of.
(v) Establishing an EU domiciled subsidiary and applying for tied agent status with a MiFID authorised entity;
The main advantage of this route is that the marketing initiatives can be done in the name of the fund sponsor’s EU entity, rather than that of a third party. There is the additional work of running a separate legal entity in the EU, including ensuring substance, corporate governance and keeping the company in good standing from a corporate filing, tax and compliance point of view. A modus operandi should also be strictly adhered to, in order to ensure that only personnel properly connected to the EU entity are undertaking the marketing activity.
(vi) Establishing an EU domiciled subsidiary and applying for MiFID permissions;
This route has the same considerations as (v) above with the added complication of applying for direct MiFID permissions. From June 2021, the new regulatory capital requirements also commence for MiFID firms, requiring them to retain at least a minimum regulatory capital of €75,000, with potential additional regulatory capital based on its activities and overheads.
For all of the above scenarios, the third country based personnel may assist with non-regulated activities including pre-marketing (currently regulated on a country by country basis until 2nd August 2021 when the Cross Border Distribution Directive commences), support with corporate advice on fundraising strategy, provision of commercial information, and preparation of fund marketing materials (subject to vetting by the authorised entity undertaking the marketing). Activities such as the potential investor undertaking due diligence on the site of the fund sponsor acting as the investment adviser and/or delegated portfolio manager should also be allowed to take place without need of the authorised entity’s supervision.
The above discussion seeks to cover a potentially EU-wide solution for the activity of marketing financial products to EU professional investors only. Retail distribution is still governed on a country by country basis. Additionally, non-EU fund sponsors applying for permission to market funds under the National Private Placement Regime may also be able to undertake marketing activity in that jurisdiction for the relevant fund.
Whichever solution the fund/investment sponsor wishes to explore with the advice of their legal counsel, Langham Hall believes it has a comprehensive, robust framework to assist in its practical implementation. We diligently keep up to date and provide a considered review of our processes and procedures to adopt new developments in legislation, practices, and industry opinions.