Building upon our previous Insight on this topic, we take a fresh look at 10 more things US fund managers need to know about marketing their funds in Europe.
New fund disclosure standards to protect EU investors
In January 2018, the Packaged Retail Investment and Insurance-based Products (PRIIPs) Regulation came into force. This legislation requires those who produce, advise on or sell PRIIPs – including investment funds – to retail investors in the European Economic Area (EEA) to prepare and provide investors with a standardised key information document (KID) (even if there is no other EEA connection).
Although fund managers running alternative investment strategies would typically not target “retail investors” in the general sense, the meaning of that term as defined in the PRIIPs Regulation also picks up most high net worth individuals – Richard Branson is famously considered a retail investor for these purposes. There may also be implications for fund managers who have any EEA-based employees co-investing in or taking carried interest from their funds.
Various concerns have been raised in the market about the practical aspects of producing KIDs, including the cost and disclosure requirements. The European Commission has been called upon to clarify these issues and we expect to see further guidance emerge next year.
Thinking of setting up a parallel fund in the EU? Substance is key
US managers looking to set up a parallel fund structure in Europe to access EU investors will need to be mindful both of the substance requirements issued by the European and Securities and Markets Authority (ESMA) last summer (here and here), and any specific substance requirements imposed by the regulator in the relevant EU Member State.
In particular, ESMA has warned against the use of delegation and other arrangements which give rise to the creation of ‘letter-box’ entities. Brexit is looming and there is clearly a desire by certain Member States to protect their domestic fund industries. As a result of this, with the regulators in the key jurisdictions (such as Luxembourg and Ireland) having their hands tied to a certain extent by wider EU policy, they will be taking a much more rigorous approach in their appraisal of authorisation applications.
Historically, Luxembourg has been dominated by European players, but it is increasingly attracting international managers looking to launch into the European market. A circular (18/698) published on 23 August 2018 by the Luxembourg regulator (CSSF) sets out detailed requirements regarding the shareholding structure, capital, management bodies, central administration and internal governance arrangements of fund management companies, and rules governing the delegation of key functions.
Can a US fund manager advise a European fund from the US, or market a US fund in Europe, without being authorised in the fund’s home state?
The issue of whether or not the activity of placing funds, or advising a fund from a third country, falls within the scope of The Markets in Financial Instruments Directive (known as ‘MiFID’) has been nudged under the spotlight since the Brexit referendum. This question (which is equally relevant to US fund managers) is likely to come under increasing regulatory scrutiny. Some larger EU investors have already queried the regulatory status of certain UK-based managers’ marketing teams, and we can foresee the same question being asked of US-based managers in the future.
US managers will need to consider whether their fund placement activities in EU Member States would be caught by MiFID and therefore require compliance with local regulation. US managers who operate parallel structures in Europe to access European investors (for example, using a Luxembourg super-manco which is advised by an entity in the US) may also see additional scrutiny on their regulatory requirements regarding the provision of investment advice.
At what point do I stop ‘pre-marketing’ and start ‘marketing’ under the Alternative Investment Fund Managers Directive (AIFMD)?
The divergence among EU Member states in their approach to pre-marketing is an issue that asset managers seeking to distribute their funds in the EU have to grapple with:
- In the UK and the Netherlands, generally speaking, marketing will only occur when final offering documents and an application form are circulated to investors. So draft documents may be circulated (as long as they are watermarked draft and have appropriate disclaimers) and investor negotiations undertaken without engaging in ‘marketing’, provided that the fund entity is not yet established.
- In Germany, the position is similar to that in the UK and the Netherlands. The circulation of draft fund documents should fall within the scope of ‘pre-marketing’ provided that (i) it is made clear to investors that the setting up the fund is a future project (i.e. that the fund has not yet been established); (ii) the draft documents still have gaps that need to be negotiated (in particular regarding any investment conditions that are to be included); and (iii) the draft documents do not imply that the fund is ready to be marketed to investors (for example, by referring to “finalised investment conditions” or similar).
- In France, the scope of pre-marketing is generally considered to include a management company contacting up to a maximum of 50 investors (professionals or individuals whose initial subscription would be at least EUR 100,000) to assess their interest prior to the launch of a fund – provided that the investors are not given any subscription form and/or documentation containing definitive information on the fund’s characteristics that would allow them to subscribe to the fund or commit to do so.
- In Italy, the circulation of draft fund documents should fall within the scope of ‘pre-marketing’ provided that (i) the fund entity is not yet established; and (ii) the draft documents do not contain specific and detailed information of the financial product to be offered.
While the European authorities are currently considering proposals which could harmonise elements of pre-marketing across Europe (bringing them broadly in line with the current approach in the UK), these proposals are still to be agreed and then implemented. See our recent article on this.
The ‘B’ word
As things currently stand, the UK will leave the EU on 29 March 2019. Absent an agreement between the UK and the EU on a transitional period, this means that with effect from 30 March 2019 UK AIFMs will automatically lose their AIFMD marketing and management passports. Critically for US managers, this means that they will lose their ability to access the rest of the EU through the UK via passporting from that date. However, given that US managers with parallel structures for European investors have typically favoured Ireland or Luxembourg to establish their European funds, this should have less of an impact.
Responsible investing: no longer a box-ticking, compliance-driven exercise
Responsible investing has moved into mainstream investment policy. According to a recent survey from professional services firm Aon, out of 223 institutional investors around the world, 47% of European investors have a responsible investing policy in place compared to just 30% of US investors. “Global perspectives on responsible investing,” a report produced on the back of the survey, also found that investors in Europe are the most likely to have dedicated responsible investment staff (28%), while UK investors are most likely to withdraw from a manager with no responsible investing policy in place (11%).
This increased focus on environmental, social and corporate governance (ESG) principles has, in part, been encouraged by European investor demands and by greater governmental and regulatory pressures on fund managers to take a long term view. The real impetus, however, appears to have come from the recognition by increasing numbers of private equity and venture capital firms that developing an embedded ESG investment process minimises risks, creates opportunities and results in better investment decisions and returns.
European pension funds are looking to alternatives to manage portfolio risk
According to recent industry publications, many European pension funds are looking to adjust their risk-return profiles and asset allocation by diversifying away from traditional markets into alternatives (for example, private equity, infrastructure funds, real estate and private debt funds), both for strategic reasons and due to low yields across a number of assets classes. This trend is expected to continue to rise in line with the European environment of rising interest rates. In addition, amid the swing towards alternatives generally, it is reported that there is a growing interest from pension funds in hedge fund-like strategies, influenced by the increase in volatility since the beginning of this year, as a way to protect portfolios from down-side risk.
Treatment of fund costs
The disclosure of fees and expenses has been a big theme for the Securities and Exchange Commission (SEC) over the past few years. This has led to the SEC taking a number of enforcement actions against private equity firms where they have failed to properly disclose fees and conflicts of interest to investors. US managers now have to be very specific about the types of fees they intend to charge investors and this has to be disclosed prior to the investors committing capital.
Whilst the UK regulator (the Financial Conduct Authority) is not as active on this point as the SEC, there is already a regulatory requirement for fund managers to disclose fees to investors before they invest. The requirement stems from the AIFMD and fund managers have to provide prospective investors with a description of all fees, charges and expenses, and the maximum amounts borne by investors, before they invest (so-called ‘Article 23 disclosure’).
Side letters: frequently used, but you will need to disclose any preferential treatment
Side letters are a common feature of the investment funds industry and widely recognised as a useful tool for investors, particularly in closed-ended LP funds. However, increasingly in Europe, as well as in the US, fund managers need to be conscious of relevant regulatory principles around integrity, fair treatment and proper management of conflicts of interest – which may make the accommodation of certain investor requests more challenging.
US fund managers looking to market a fund in the EU under the AIFMD National Private Placement Regime will be required to disclose the details of any preferential treatment of investors. This means, whenever an investor obtains preferential treatment, or the right to obtain preferential treatment, providing a description of that preferential treatment, the type of investors who obtain such preferential treatment and, where relevant, their legal or economic links with the AIF or the AIFM.
Osborne Clarke can help
With our network of dedicated experts across Europe advising on all aspects of fund formation, promotion and operation, Osborne Clarke can help you navigate these rules.
Find out what our investment funds team has been up to recently here.