Playing the system, PERE Magazine

11th March 2015

The beginning of 2015 has seen a number of inter- national fund managers come to the European market from as far afield as Asia and the US. Those fund managers who have decided to tackle the Alternative Investment Fund Managers Directive (AIFMD) head-on are getting to grips with what needs to be done before they can effectively market to Europe. Non-EU funds, marketed by non-EU managers, are still in a blackout period where they are excluded from applying for a
cross-border marketing licence in Europe.

Instead they have to apply separately to each country where they hope to secure investors. Known as the private placement regime, each country has its own nuances as US managers are beginning to discover.

Two countries where there are extra steps to obtain licences are Denmark and Germany. Regulators there have decided that, unlike the rest of Europe, non-EU managers of alternative investment funds need to appoint a deposi- tory prior to commencing marketing in these countries. However, this is most likely a short-term difference. Within the next 12 months it is anticipated that, if a non-EU fund manager is allowed to apply for an EU-wide passport, then having a depository is likely to become a prerequisite to soliciting investors in the rest of Europe as well.

A depository performs certain functions designed to pro- tect investors, including monitoring cash flows of a fund, verifying if a fund actually owns a named asset and moni- toring the fund manager and fund to ensure it is running in accordance with key documentation and in the way in which it was sold to investors. It is not a custodian role but very much a lighter touch monitoring role. Given that there is an abundance of available capital outside Europe, it is easy to see why US fund managers might ignore countries within Europe. Many of them view an overall commitment of less than 5 percent to Denmark and Germany as too difficult to navigate or to justify the cost to existing domestic US investors. In many cases they are right, however if a fund manager genuinely thinks there is an opportunity it is difficult to ignore the prospect of opening up new chan- nels of capital, despite the cost and protests from the fundmanager’s back office.

For those taking the plunge, the logistics and timings of these applications need to be thought through carefully. 

Recently, one firm launching a domestic US private equity real estate fund wanted to target European investors, but was under enormous pressure to start and complete fun- draising quickly. Having registered in various European countries under the normal private placement regime, the placement agent pushed hard to target German and Danish investors, traditionally major investors into global real estate. However, the problem faced by the fund manager was the time required for Denmark and Germany’s regulators to approve an application. This can be lengthy, indeed, an application can take 8 to 12 weeks to determine and the regulators insist on seeing a depositary agreement at the time the application is submitted. The fund manager considered reverse solicitation but the perception within the market was that this is becoming rarer because the German regulator is apparently monitoring German LPs commitments to funds.

To delay Danish and German LPs to a second close is unfair as this excludes them from preferential first close terms offered to domestic US investors. The only way to pre-empt this and allow everybody an opportunity to secure incentives for coming into a fund early is to run the marketing applications and depositary selection process right at the beginning. On the face of it, this doesn’t sounds too difficult, however, the domestic US market is not used to providing this service at the required cost and in a light touch way. A fund manager might consider appointing a bank that can act as a depository. However, banks often have a rigid way of dealing with the funds which seek their services due to them having up to $1 trillion or more liquid assets in custody and therefore not wanting to introduce a less expensive and more flexible business model. As such banks’ processes can be intrusive, perhaps insisting on pre-approval of investment transactions, or being unable to accept information after the event – this is not unexpected when most of a bank’s assets are held in custody.

One can understand that this is not attractive to US firms that have to move at lightning speed to complete a deal. This is why some are now talking to the small number of fund administrators who provide these services to explore a more user-friendly way of working.

Some firms like ours are depositories. In our case, from London we provide services to real estate fund managers in Europe and more recently in the US for Delaware funds or “non EU AIFs” as they are known. The idea is to operate quietly behind the scenes and provide a non- intrusive monitoring role which leverages existing procedures and internally generated information. US managers have been reassured that, once over the initial set up of securing their marketing licences and appointing depositaries, the ongoing operation has not been as onerous as anticipated.

It appears that the US market has moved forward significantly in the past 12 months towards accepting the proposed changes to doing business in Europe. With domestic tightening of the rules, US man- agers are feeling the weight of regulation – much like their counterparts in Europe. Once up and running, Annex IV

reporting for each of the countries they reg- ister in is another area where fund managers will need assistance. It will be of no surprise that the formats differ from country to country; it has been a sharp learning curve for the whole industry.

It may be that the decision is not just about whether or not to pitch to Denmark and Germany but whether to pitch to Europe, as it is likely the rest of the market will go in that direction. Even non depositary requirement countries are asking if funds have depositar- ies in place. It is still possible to defer the need to comply but ultimately the need to embrace it feels somewhat inevitable.

Rob Short is managing partner and founder of Langham Hall, a professional services firm based in London. Prior to establishing the firm in 2006, he was at Goldman Sachs where he led the European real estate fund adminis- tration team administering the Whitehall funds, controlling financial information and reporting on $12 billion of funds with operating partners in a dozen countries.