Operationally 2021 was challenging, not just for advisors but also for fund managers and investors. Adapting businesses to suit the shifting aspirations of staff while continuing to service the indefatigable demand for new product has proved an interesting combination.

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Some interesting trends emerged this year. The largest real estate and private equity fund managers were able to launch new product successfully, partly as LPs struggled to meet new GPs and partly due to perceived reduction in risk. Repeat mid-market fundraises for the highest quality managers were also still successful, albeit a great deal of work for teams numbering between 10 and 30 people. Competition for deal flow became more intense, with managers needing to hold their nerve and stick to underwriting models when acquiring assets. As far as I can tell, people are being disciplined and gearing levels remain sensible.

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It’s the lower mid-market where we’ve seen most change over the past 12 months. Private equity funds have adapted to a change in strategy, both in terms of industry focus with more technology, healthcare, food science and social impact funds coming to market, but also in how they measure the non-financial performance of their funds in terms of portfolio company KPIs. By this I mean ESG related factors and the speed with which they can adapt their focus. It has been much harder for lower mid-market real estate. Retail and offices have suffered greatly over the past two years leaving managers to focus on the overheated residential and industrial sectors. Although a handful of niche sectors are developing, generalist mid-market first time funds are very difficult to raise. The consolidation of UK investors, their propensity for direct investing, and the difficulty converting existing buildings into tenant and environmentally friendly assets, means that the headwinds for smaller fund managers will take a while to navigate and they will be confined to deal by deal strategies for the time being. That said, there is a great deal of investible cash looking for inflation proof investments, so the future still looks very positive.

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Langham Hall Group Update

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The group achieved organic turnover growth of over 25% in 2021, with our headcount growing from 480 to 580 people. A combination of repeat funds across all jurisdictions, together with greater complexity such as co-investment, parallel vehicles and complex underlying structures, all contributed. We observed a continued shift of funds to Luxembourg and a significant number of US GPs entered the AIFMD environment, sometimes with limited Annex IV reporting or depositary light services but many opting for full parallel fund services, such as host AIFM, administration and depositary services. The new generation of lower mid-market private equity funds have resulted in significant growth of the Guernsey business over the past 12 months. The US and Asian markets remain buoyant and continue to see significant growth. Our Asian business remains the largest administrator of private equity funds locally.

I have included summaries below from each of our jurisdictions:

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New York

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The US business grew from 14 to 20 people this year, adding several valuable private equity and real estate clients. We are moving into new offices early this year to accommodate growth and issued the first SOC 1 controls report in 2021. We are in the process of completing the second annual SOC 1, to be issued in early 2022.

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London

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In the UK our private equity business grew 50% last year – an outstanding achievement given some lingering post-Brexit uncertainty. This was made up mostly of mid-market UK focused private equity fund managers. The real estate business continued to post double digit growth despite significant headwinds, such as the lack of lower mid-market funds. We continued to be the market leader in the UK for depositary and Annex IV reporting, mostly for US funds marketing in Europe. We added 20 new US GPs in 2020 and 40 GPs last year. There are now seven clients in the $5-10bn commitment range.

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Hong Kong and Singapore

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Our Hong Kong and Singapore teams continued to support their significant portfolio of Asian managers with new fund raises, while winning and onboarding new high-quality managers in Singapore, Japan and Korea. The Wolfram team continued to develop its fund KPIs dashboard and, in collaboration with Wolfram, developed a new Transaction Capture tool. Due to expansion the Singapore office signed a lease for its own office space.

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Luxembourg

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Our Luxembourg office remains a leader in the servicing of RE and PE funds and is one of the fastest growing jurisdictions, with a current headcount of approximately 140. The excellent reputation, client base and sustained growth of the Luxembourg business meant that it attracted some of the highest quality funds in the market. Staff retention remained strong, despite the challenges in Luxembourg.

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Guernsey

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Guernsey continued to grow, and the team increased from 24 to 39 people over the past year. It received great feedback from clients, whilst acquiring several significant new mandates, and staff members achieved exam success across the board. As well as launching successor funds for almost all clients last year, a number of high-profile clients have moved over to us. Langham Hall is now seen as one of the go-to fund administration businesses in Guernsey, and all credit to the team for achieving this reputation.

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Jersey

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Existing clients, who are not reliant on Europe for their investor base, continue to support our Jersey business. We closed one fund at over €1bn and two more of that size are in the pipeline for existing clients, ensuring the business retains double digit growth. Both Jersey and Luxembourg completed the successful roll out of their new compliance databases.

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Host AIFM

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The AIFM business in Luxembourg has achieved the highest percentage organic growth amongst our competitors, at 100% year on year growth of new funds under management against a peer group average growth of 42%. This growth occurred in an increasingly complex legal and regulatory environment around Brexit, pre-marketing and marketing cover in the EU, new laws around ESG and taxonomy and ever tighter ESMA and CSSF scrutiny.

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Group-wide initiatives

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There are many exciting group-wide initiatives underway too. We are in the middle of the design phase of our new website and ESG is featuring significantly in our client work. We used our Wolfram computable data technology to develop our prototype ESG dashboard last year and are looking to test this on clients and enhance it this year. The new Development Pathway training initiative aims to enhance the way people learn at Langham Hall.

In closing, I remain thankful that, despite the challenges, we have been able to grow the business. I would like to thank our clients, staff and advisors for their loyalty and support. I am excited about 2022 and look forward to what the next twelve months will bring.

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Best wishes,

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Rob Short
Managing Partner

On January 1st 2021, the Brexit transition period came to an end, which meant that all UK domiciled Alternative Investment Funds (‘AIFs’) and Alternative Investment Fund Managers (‘AIFMs’) are now treated as “third-country” for the purpose of the Alternative Investment Fund Managers Directive (‘AIFMD’).

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Previously, for UK domiciled AIFMs and AIFs Annex IV reporting was only required to be filed with the FCA as the home regulator. However, since the end of the transition period, any UK AIFs that have investors from EU jurisdictions which were marketed to under AIFMD must now submit Annex IV reports to every country from which they have accepted subscriptions (except where there has been genuine reverse solicitation).

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There is no harmonised system for completing and filing these reports across the EU, rather each regulator has its own reporting portal with various nuances in reporting format and process. This reporting burden often falls to fund finance or compliance teams who may be unfamiliar with the reporting process, which will be required for all AIFs by 31st January 2022, and potentially as often as quarterly thereafter depending on the requirements.

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Langham Hall has been completing Annex IV reporting for non-EU AIFMs and AIFs since 2014. We prepare and file hundreds of annex IV reports each year and are familiar with each regulator’s reporting portal. Langham Hall is able to set up the portal access for each country, and complete and file these Annex IV reports in the relevant formats required by each regulator. We file these reports directly with the regulator with minimal involvement required from the fund manager

Since 2013, Alternative Fund Sponsors wishing to market their funds into Europe have had to navigate the Alternative Investment Fund Managers Directive (“AIFMD”). In recent times, fund sponsors are getting more familiar with AIFMD, and the optionality of using a Host AIFM to provide a robust regulatory framework without spending upfront time and expense in getting their own AIFM licence.

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It has been the case from the outset that institutional investors around Europe have accepted this model, and indeed it has been no bar to fundraising, whilst providing a solution for those investors (usually German pension funds and insurance companies) who prefer to operate in an AIFMD compliant fund structure rather than an offshore structure. However, AIFMD remains a complex piece of regulation and non-EU Fund Sponsors in particular are not used to handing over the reins to a third party service provider, who is by law bound to look after the best interest of investors.

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Nevertheless, we have recently seen an uptick in interest in Host AIFM services in Luxembourg from those non-EU Fund Sponsors looking to market to the large pool of institutional capital found in Europe. US and Asian fund managers are reviewing this option again when they need (i) to speak to investors in jurisdictions with unworkable national private placement regime (such as Spain, Italy and France), (ii) and to set up a fully AIFMD compliant parallel vehicle to accommodate the specific requirements of, inter alia, German institutional investors. A Host AIFM solution is a quick and cost efficient way to achieve their commercial objectives, rather than to go through the process of setting up an AIFM themselves in Luxembourg, especially in light of the detailed infrastructure and personnel requirements as outlined by the CSSF in Circular 18/698 released in August 2018.

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There are many advantages to appointing a Host AIFM, but the perceived loss of control in the investment making-decision process is often the largest concern of fund managers. Ultimately, there is another party involved. The fund counsel and the Host AIFM therefore should explain what is required at the outset. The typical questions usually concern:

• The allocation of responsibilities between the General Partner (‘GP’) and the AIFM. It is important to be aware of the market practices as there is no clear guidance in the relevant regulations.
• The difference between the advisory model and the delegated management model. The latter is now the preferred route to minimise the Host AIFM involvement in a decision-making process, subject to the fund sponsor’s regulated status in their home jurisdiction.

Allocation of the powers between the General Partner and the Host AIFM:

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Today in Luxembourg, most of the investment funds which are fully AIFMD compliant are established as an unregulated limited partnership managed by a GP which in turn needs to appoint a full scope AIFM (‘Alternative Investment Fund Manager’). AIFMD is practically silent on the role of GP. Under the Luxembourg Company Law, the strategy and management of a fund remains the legal responsibility of the board of the GP.

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This being said, the AIFMD defines AIFMs as any “legal person whose regular business is managing one or more AIFs”. “Managing AIFs” is then defined as “performing at least investment management functions for one or more AIFs” (the investment management functions being portfolio management and risk management).

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Even if there is no single definition of portfolio management in the relevant regulations, it usually involves the process of selecting, acquiring, managing and disposing of the assets of the AIF.

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Keeping this in mind, it is therefore crucial that the fund documentation is properly reviewed to avoid confusion, and to clearly differentiate the allocation of functions between the GP and the AIFM. The constitutional documents of most AIFs usually states that the GP shall have all rights and powers with respect to the AIF that may be vested in the GP under the corporate law, subject to any limitations specifically set in the AIFM agreement and provided that the GP shall not do anything or exercise any powers which constitutes a regulated activity under the AIFM regulation.

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In practice, it means that anything related to the investment approval is within the AIFM scope, i.e. the approval of the investment itself, CAPEX budgets if any (in the case of real assets) and follow on investments (in case of private equity and venture capital). There are differing views on whether financing (including the hedging policy) is allocated to the AIFM but the prudent view to take is that the financing assumptions should always be taken into account when approving an investment, obviously subject to the GP reserved matters.

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The role of the GP will be limited to the coordination of the capital pursuant to investment approvals of the AIFM. The execution of the transaction documents usually takes place at the level of special purpose vehicles (‘SPVs’) in accordance with the legal and tax requirements of the jurisdictions where those SPVs have been established.

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In this context, it is necessary to agree and document the operating model in advance. It will enable all parties involved in the investment process to work together to approve and execute all the transactions on a timely basis. It can also be very convenient to work with a service provider that can offer a “one-stop shop” solution, i.e. Host AIFM, administration and depositary services. This model allows the service provider to fully coordinate the investment approval process, particularly in respect of the Host AIFM and the GP (usually administered by the service provider).

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Advisory vs Delegated Portfolio Management

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When a Fund Sponsor appoints a Host AIFM, the investment management process can be managed applying either the advisory model or the delegated model. The Fund Sponsor will be involved in the investment process by acting as a portfolio manager (delegated model) or as an investment adviser (advisory model).

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Delegated model:

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Under the delegated model, the portfolio manager makes all the investment decisions, and the Host AIFM then carries out oversight of the portfolio management activities and undertakes the risk management function.

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In funds with illiquid strategies which are investing in non-fungible assets, the investment decision and risk management considerations are necessarily intertwined, with both qualitative and quantitative risk factors needing to be considered (unlike hedge fund AIFs where the risk management is mostly a quantitative check on investment limits). What happens in practice is that the investment paper prepared by the portfolio manager is also reviewed by the AIFM for risk management. Under AIFMD, the AIFM can only delegate either the portfolio management or risk management functions, but not both. However, the commerciality of the decision will be decided by the portfolio manager and the AIFM will note the risks of the transaction.

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The AIFM’s liability towards the AIF and its investors will not be affected by the fact that the AIFM has delegated functions to a third party, therefore it is imperative that the AIFM understands from the outset the portfolio manager’s internal investment process and has done the requisite due diligence required under AIFMD. Consequently, a delegated portfolio manager must also comply with the requirements of AIFMD, the portfolio manager will have additional obligations and requirements to handle including regular reporting to the AIFM.

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Requirement for a portfolio management licence:

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To act as the portfolio manager, the entity must be authorised or registered to provide asset management services, and subject to supervision in its home state, or, where that condition cannot be met, prior approval by the Commission de Surveillance du Secteur Financier (‘CSSF’) will be required before to taking up the portfolio manager role.

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The following entities are deemed to be authorised or registered for the purpose of asset management and subject to supervision: UCITS management companies, investment firms authorised under MiFID to perform portfolio management, and third country entities authorised or registered for the purpose of asset management and effectively supervised by a competent authority in those countries. Where the delegate is a third country undertaking, cooperation between the CSSF and the supervisory authority of the portfolio manager must be ensured. This cooperation is usually evidenced by a Memorandum of Understanding (‘MoU’). A list of all MoUs entered by the CSSF with foreign regulators is available on the CSSF website.

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Compliance with the European Securities and Markets Authority (‘ESMA’) Remuneration guidelines:

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The AIFMD provides that each AIFM must have remuneration policies and practices for prescribed categories of staff. When portfolio management is delegated, the ESMA Remuneration Guidelines require that the delegate should be subject to regulatory requirements on remuneration that are equally as effective as those applicable under the Remuneration Guidelines. There are also disclosures to be made usually in the annual accounts of the fund.

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Host AIFM supervision of the portfolio manager:

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It is crucial for the Host AIFM to ensure that all investment decisions on behalf of the fund are carried out in compliance with the objectives, the investment strategy, the risk profile and the risk limits of the fund. In practice, the AIFM would, having satisfied itself of the infrastructure, professionalism and commercial acumen of the portfolio manager, leave the decision-making process to the portfolio manager and only intervene and raise any questions if really necessary, and on a timely basis. Relying on the commercial acumen of the portfolio manager, it is expected that if the AIFM raises any issues, it is mostly for clarification on an investment or ensuring regularity with market practice and compliance with the investment restrictions and laws in the process of transacting.

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Furthermore, the portfolio manager will provide to the Host AIFM all information concerning the investments to enable the Host AIFM to fulfil its duties in relation to risk management and liquidity management.

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Conflict of interest:

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The AIFMD precludes delegation in circumstances where it conflicts with the interests of the AIFM or investors of the relevant AIF. This may be applicable if the delegate itself is controlled by an investor in the relevant AIF, or the delegate is likely to have a financial or other incentive to favour the interest of another client over the interests of the AIF or the investors in the AIF. The Host AIFM would usually declare in the AIFM agreement that it may act for other funds with the same strategy and will only consider transactions which are proposed by the appointed portfolio manager.

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Advisory Model:

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Under the advisory model, the investment advisor advises the AIFM with respect to the investments and divestments of the fund. The investment advisor would usually still have its own internal investment committee meetings, but it is the investment committee of the AIFM that makes the decisions based on the recommendation of the investment adviser. The investment advisor’s activities comprise of sourcing opportunities, conducting due diligence, providing investment recommendations, assisting with carrying out the transactions and assisting with reporting in the management of the investments. Note that the investment committee of the AIFM can possibly include personnel of the investment advisor subject to certain restrictions (i.e. an advisory role without any voting rights).

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Does the fund sponsor need a licence?

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Investment advisers may be regulated (i.e. authorised and supervised) or unregulated (albeit under certain conditions). EU investment advisers which provide advice to third parties in respect of one or more transactions relating to financial instruments, must be regulated. Non-EU based investment advisers may have to register with the CSSF unless they are appointed by the Host AIFM and/or fund on a reverse solicitation basis¹. This registration requirement recently introduced by the CSSF applies until activation of the third country MiFID passport. The purpose is for the CSSF to assess whether the non-EU adviser is subject to equivalent regulatory requirements in its home jurisdiction prior to authorising any services to Luxembourg based professional clients (such as the Host AIFM and/or the fund).

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From one jurisdiction to another, the requirement for permissions and the scope of authorised activities can be significantly different. The fund sponsor may need therefore to seek legal advice from the fund counsel and the Host AIFM.

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How to mitigate the risk of delay?

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As mentioned previously, one of the key concerns fund sponsors often have with the Host AIFM model may be the loss of control in the investment decision-making process, and the risk of delay in the execution of the transaction. This is particularly relevant under the advisory model, and even more so when there are many investments (i.e. secondary markets or venture capital). It is therefore crucial for the fund sponsor to discuss and clearly understand how the investment process will work in practice. Under this model, the typical investment approval process consists of three key steps.

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First, it is necessary for the Host AIFM to have a clear understanding of the deal pipeline on a regular basis. Sharing, for example, a pipeline report every month is considered good practice, including details of the current stage of each opportunity. Investment papers/details can be batched for approvals.

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Then, as the Host AIFM will approve any due diligence budget for new projects, it can also take the opportunity to review the key terms of the investments, and perform a preliminary check against the investment strategy and the investment restrictions. This approval typically takes place between 3-5 days before the start of the due diligence process.

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Finally, once the host AIFM has sufficient understanding of the deal, and assuming all the required information has been received from the fund sponsor on a timely basis, then the final approval will take a maximum of 48 hours. Key to timely sign off from the Host AIFM is undoubtedly proper preparation in advance of the deal.

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Is it really difficult to be AIFMD compliant?

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Especially under the advisory model, the fund sponsor may feel that the Host AIFM option is an intrusive process. However, we do believe that once it is properly explained and fully understood, it is less onerous than expected and can become a routine process.

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The requirements under AIFMD, as supervised by the Host AIFM should also reduce litigation risk for the fund sponsor as there would be proper processes and documents to support all material decisions. The key point is the capacity of the Host AIFM to adapt to the fund sponsor’s existing processes, particularly if the fund sponsor is already regulated in another jurisdiction. It is only possible if the Host AIFM team has a very good understanding of the AIFMD and of the relevant market practices.

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Under the host AIFM model, the fund sponsor is sharing the Host AIFM platform with multiple funds. It is therefore critical that the Host AIFM that will appear on the fund documentation remains free from legal action or any reputational damage.

This legal and reputational risk is one that the fund sponsor should carefully consider when deciding to appoint a host AIFM, and so it is essential to assess the quality and expertise of the team working for the Host AIFM. Staff selection is important, not only to give the platform substance for effective supervision of the fund sponsor, but also to have an efficient, commercial process for decision making. Anticipation of potential problems is key. A poor quality team can erode the time of deal professionals, given that any sign-off at Host AIFM level is often needed quickly during the deal cycle. In a worst case scenario it could even allow a decision to be made which may lead to litigation at a later date.

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Furthermore, the Host AIFM is required to demonstrate its effective supervision over the portfolio management process, this means proper meeting minuting and supporting paperwork collating processes. Any gaps or lack of tracking can cause more risk for the client and the Host AIFM, and as is heavily documented, can even be prejudicial in case of litigation.

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Langham Hall is an award-winning provider of Fund Administration, Depositary and AIFMD services to global fund managers. To hear more about how we can help, whatever the requirements, please get in touch with a member of our team.

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_{1 Refer to CSSF circular 19/716 on the provision in Luxembourg of investment services or performance of investment activities and ancillary services}

Private Equity and Real Estate fund sponsors are increasingly pooled into two groups: those that are choosing to run their funds from Luxembourg with the benefit of EU marketing passport; and those that opt for a UK or Channel Island structure and market under the old private placement rules.

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Both jurisdictions offer innovative products and structures which suit nearly all type of investors and fund sponsors. In addition, they are highly regarded for the quality of their service providers, law firms and regulatory environment. Despite the general similarities in operating a fund from an offshore fund hub (Channel Islands) and an onshore fund hub (Luxembourg), some nuances exist in the operational model in each jurisdiction. This article sets out the main differences.

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Regulatory Differences:

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Both Channel Islands and Luxembourg have robust regulatory framework in relation to managing and operating fund structures. Jersey and Guernsey had implemented changes in readiness for the rollout of the Alternative Investment Fund Managers Directive 2011/61/EU (AIFMD) to third countries and was recommended to be approved for equivalence to benefit from the EU-wide marketing passport by European Securities and Markets Authority (ESMA). However since Brexit, there has been diminished drive by ESMA to open up the EU marketing passport to any third country.

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Funds based in Luxembourg which are subject to the full requirements of the AIFMD has the benefit of EU-wide marketing passport, and is therefore perceived to have better investor protections. This means operating under a more regulated and prescriptive regime. For Fund Sponsors usually operating out of Channel Islands, launching their first fund in Luxembourg may take a little getting used to as under AIFMD there are more formalised procedures than requirements in the Channel Islands.

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Primarily, the main difference between the Luxembourg and the Channel Island operational model is the involvement of a regulated (external) Alternative Investment Fund Manager (AIFM) in Luxembourg, whose main functions are portfolio management, risk management and valuation oversight. These functions are mandated by AIFMD. The portfolio management and risk management functions need to be independent of each other and the AIFM may delegate only one of those functions. The AIFM has to formalise internal procedures for portfolio management, implement risk matrices and valuation processes (including drafting a valuation policy) and perform several reportings to the supervisory authority of the Luxembourg financial sector (CSSF) for each Fund on a regular basis. This may sound burdensome in comparison to a Channel Island model where the General Partner takes the decisions for the fund through ordinary board minutes but in practice those differences are only marginal vis a vis the Fund Sponsor as most of the tasks may be undertaken by a third party host AIFM such as Langham Hall in the background. These procedures, processes and documentation must stand up to CSSF audits which they do as standard.

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Taking the investment process as an example, whereas in Channel Islands, the investment adviser will be presenting their recommendation for portfolio management matters (e.g. investment, divestment, financing etc) to the General Partner in a partnership structured fund, in Luxembourg this will be presented to and considered by the AIFM, unless a delegated portfolio manager is appointed in lieu of an investment adviser. The delegated portfolio manager may be the fund sponsor subject to its regulatory permissions to act in such capactity. The General Partner would receive formal notification of the AIFM approval of such action and implements the decision thereafter.

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Funds within the full scope of AIFMD will also require the appointment of a Depositary which will have the main functions of verification of ownership of assets, cashflow monitoring and general oversight of the AIFM and the fund.

There are also detailed and specific provisions to be considered in discharging the risk management function, review of asset valuations, fund operating conditions and remuneration disclosures which have no equivalence in the Channel Island jurisdictions.

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As a consequence of the above, the on-boarding phase between AIFM, Admin and Fund Sponsor does take a slightly longer time to ensure agreement of a Service Level Agreement comprising all relevant processes and procedures for the operations of the Fund.

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Practical Differences:

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Fund set-up – In Luxembourg, the most popular fund structure is the SCSp (special limited partnership) and is similar to the equivalents in the UK and Channel Island jurisdictions. The set-up of the SCSp is fairly simple as it can be done via private deed. However the set-up of the general partner (usually in the form of a S.à r.l. – a limited liability company) is more complicated than in the Channel Islands as the creation of the company is done by notarised deed. As the notary needs to confirm that a minimum share capital of EUR 12,000 has been fully paid up, the company needs to first open a bank account for itself (which at the time is a non-existing company) in order to pay-in the share capital. Fund Sponsors should expect some time for the opening of a bank account as all entities involved in the process are regulated (e.g. bank, the administrator) and require satisfaction of Anti-Money Laundering procedures. The notary has to be engaged and the articles of the company, if in English, will need to be translated into one of Luxembourgish, French or German.

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Timing to market – This may also be slightly slower in Luxembourg as the AIFM needs to register the fund with the CSSF firstly for management and after it receives such confirmation of registration, for marketing purposes in the relevant jurisdiction which it may file for marketing. In the Channel Islands, if using fast track regimes, the regulators can authorise the General Partner and fund in 1 to 10 days (depending on the product).

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For fund sponsors operating out of the UK, the Channel Islands has A more aligned public (bank) holidays than Luxembourg (which also has more bank holidays) and this should be borne in mind when transactions are time critical.

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The above provides the high level overview for fund sponsors between the differences in Luxembourg and in Channel Island for operations of funds. In many cases, there would be various factors taken into considerations to select the right jurisdiction. These may include: location of existing infrastructure and personnel, target investors‘ requirements and preferences for one or the other, route to marketing in a specific jurisdiction in lieu of getting an EU marketing passport, size of fund, tax treatment vis a vis the underlying investments, regulatory considerations, and comparison of the ongoing cost of operations in Luxembourg and Channel Islands.

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Certainly, Luxembourg is generally a more costly place to operate a fund due to AIFMD requirements. However it does have the benefit of ease of marketing across the EU jurisdictions (some of which would otherwise be difficult to penetrate without the EU marketing passport), may be an appropriate jurisdiction for tax efficiency and is a requirement for some investors who prefer on onshore jurisdiction regulated by the AIFMD. Ultimately, what is right for one fund may not be right for another depending on the fund sponsor’s specific objectives.

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However, in terms of the implementation by the fund sponsor in either jurisdictions, there are in practice only nuances in the day-to-day operations and the interactions between the Fund Sponsor and the various service providers if a fund sponsor uses a Host AIFM to undertake the additional regulatory requirements under AIFMD. Langham Hall is in eight jurisdictions including a well established operation across Guernsey and Jersey in the Channel Islands with an office of circa 100 personnel and circa 78 personnel in Luxembourg across a one-stop shop offering Of Administration, Host AIFM and Depositary service lines. We are agnostic in our advice between these jurisdictions and would freely share our experiences in respect of funds we see choosing one over the other.

Following 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.

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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.

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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.

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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.

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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:

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(i) Engaging an EU-domiciled, MiFID regulated placement agent;

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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.

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(ii) Having a director of the General Partner (only for limited partnership structures) undertake the marketing activities;

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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.

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(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;

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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.

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(iv) Engaging the host AIFM managing the fund to undertake the marketing activity;

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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.

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(v) Establishing an EU domiciled subsidiary and applying for tied agent status with a MiFID authorised entity;

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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.

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(vi) Establishing an EU domiciled subsidiary and applying for MiFID permissions;

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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.

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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.

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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.