12th June 2019
Marketing under AIFMD remains a confusing concept to non-European fund managers. Although over the past five years we have observed a gradual increase in the take up of the full passport, it is usually preceded by months of deliberations as to the best route and often ends up with either ignoring Europe or with marketing under the current regime – the National Private Placement Regime.
The majority of non-European clients we have assisted have been North American, although more recently there has been an increase in interest from Asia. In the event of a no-deal Brexit, UK managers, without an additional EU presence, will face the same requirements as the US and Asia.
The deliberation process is unique to each manager and largely depends on the perceived success in attracting capital; something they need to decide early on due to the costs involved.
The four approaches taken by non-EU managers to European marketing broadly fall into the following categories:
This has often been the initial reaction of managers as they grapple with the complexities of AIFMD requirements. For managers with no prior European track record, no strategic reason to go into Europe and/or sufficiently strong domestic LP interest, a decision to stay away is probably best. For funds raising below $500m, this is especially true as the costs of registering, hiring a placement agent, legal fees and Annex IV fees do add up.
A direct approach from a European investor may negate the need for a manager to engage with the AIFMD marketing rules. Whilst there are of course legitimate approaches, occasionally managers have used reverse solicitation to avoid AIFMD requirements. In the past it was not unusual to hear of entire fundraisings in Europe using reverse solicitation.
The approach by managers falls into two groups, again largely dictated by size. Fund managers raising over $1bn per fund tend to be more risk averse. Managers below this can be split 50/50 between those who are cautious and those that are willing to take the risk, usually on the basis nothing “bad” has happened to anyone yet.
Advisors are similarly polarised. Some placement agents are extremely worried about firmwide and personal liability of mis-selling fund commitments. With a US manager, the European branch of a placement agent may be the only European regulated entity in the firing line. When fund performance is perceived to be strong the chances of challenging the original marketing of the fund may seem remote. However, given where we are in the economic cycle, the risk of a downturn on performance and perhaps the chance that investors may “dust off” the limited partnership agreements to look for loopholes is starting to focus a few minds. That said, there are one or two others that may be more willing to assist managers to navigate the paperwork. While staying on the right side of regulatory requirements, it’s a significant grey area that is open to scrutiny.
We believe the legal regulatory advice is gradually shifting to a more risk averse basis. International funds work has been shifting to a small group of top US law firms for some time and their position is naturally about mitigating risk. That said, some clients apply immense pressure on advisors so there may be some difficult conversations forthcoming.
A further difficulty with relying on reverse solicitation is that there are currently no harmonised rules on what reverse solicitation entails and what works in one country may not be acceptable to the regulator in the next country.
ESMA recently published a proposal for a new Directive which would harmonise the meaning of “pre-marketing” for EU managers. What may be deemed reverse solicitation under today’s rules, is likely to fall into the definition of “pre-marketing”. Whilst this lowers the regulatory burden for pre-marketing (notification process only) so that fund sponsors can take a view on the potential interest from EU investors, once investors are identified via the pre-marketing route, the fund sponsor will have to register the fund in the relevant jurisdiction to be able to admit the investors within 18 months of the commencement of the pre-marketing.
This route does, however, alleviate large abort costs if at the outset, the pre-marketing exercise fails to show sufficient interest from the LPs in the EU to go through the exercise of registering with the relevant jurisdiction. Whilst this proposed Directive does not apply to non-EU managers, it does expressly prohibit EU member states from adopting a regime that is more advantageous for non-EU managers than for EU managers. If adopted in the current draft, it is likely to effectively prohibit any reliance on reverse solicitation. (The proposal is currently expected to go live in summer 2021.)
It should be noted that, while we are unaware of any instance of an LP suing a GP for mis-selling a fund during the AIFMD era, it is entirely possible that a disgruntled LP will do so at some stage. Vehicles of 2013/14/15 origination will soon start to wind down and as discussed, any negative performance could be the catalyst to start pouring over the marketing small print. From a regulatory perspective, we understand that the CSSF now occasionally asks managers how LPs have invested where they have not registered under NPPR. Evidentiary burden will be on the managers to evidence reverse solicitation and quite apart from LPs who may claim the investment is void from the original unregulated marketing, managers may be exposed to risk of criminal and civil penalties and fines in various jurisdictions if fraudulently claiming reverse solicitation.
Use the National Private Placement Regime (NPPR)
This is the process of registering a fund to market in each target EU jurisdiction individually. Whilst not complex, there are a number of different regulators to deal with, each with their own requirements for either notification or registration prior to marketing.
We service funds using this method, ranging in size from $250m to multiple billions of dollars, many of which have been Delaware or Cayman domiciled. In the past we frequently saw a blanket approach with applications to 8+ jurisdictions. While this approach is still used by some to increase the chance of success, we recommend NPPR to managers focusing on a limited number of countries where the groundwork has been put in place. The process is very quick for four or five of the most common countries including the UK, Ireland, Luxembourg and the Netherlands and, in fact, the UK takes only a couple of days. Germany and Denmark require a depositary if the manager is successful in raising money but be aware that the regulator can take 8-12 weeks.
Anecdotally, NPPR seems to be unattractive for managers seeking less than $50m from European investors. However, those who have successfully raised funds via NPPR have now done so with multiple funds and often with different strategies. This is an appropriate approach for those not needing to be opportunistic or wanting to target hard to reach jurisdictions such as France and Spain.
Establish a presence in Europe under a regulatory umbrella
For our client base this typically means setting up a Luxembourg parallel fund. This approach requires a larger number of services (host-AIFM, fund administration, domiciliation and depositary) but, despite the higher costs, can still be a relatively quick route to market and gives full access to the EU marketing passport. Placement agents will likely want to have unrestricted access to investors and the passport allows a more opportunistic stance to be taken.
Conceptually this option is a step further into AIFMD than some are prepared to go, however, it provides the fastest route to the marketing passport. This option is popular with managers seeking in excess of $1bn global capital and who are looking for a European sleeve to augment capital already coming into a Delaware or Cayman structure.
Establish a presence in Europe with own EU AIFM
This option requires the greatest investment of time and money but gives managers who choose it the most control with the greatest access to LPs. This approach requires the manager to provide all staff and directors for substance requirements, which can be challenging.
This approach isn't just for the largest managers with multiple billions under management and long-term European strategies. It is increasingly being considered by UK managers looking at a Brexit backup plan.
AIFMs can be domiciled in any EU jurisdiction, although the default domicile for funds remains Luxembourg and occasionally Ireland or Amsterdam.
In our view, the decision to market in Europe comes down to whether you have a very small number of LPs from certain countries and you can take a ‘rifle shot’ approach to marketing. If the fund is big enough, then those wanting more wide-ranging marketing opportunities in Europe or who want to reach certain difficult to access countries the Host AIFM solution should be considered. Many managers have started with NPPR and graduated to host AIFM as their marketing footprint has increased.
From Annex IV reporting and depositary-lite through to host-AIFM, domiciliation and fund administration, Langham Hall provides services for managers whichever route is taken. We are a professional service firm and our global network of eight offices across three continents means we have a wide view of non-EU managers either considering options or actively marketing their funds in the EU. We know the best service providers.
If you would like to discuss any of these approaches in more detail, we would be very happy to hear from you. We share our market insights to help you make the most informed choice for your business.