As part of an initiative to minimise trading barriers within the single market and thus deepen the Capital Markets Union, the European Commission has proposed legislation aimed at easing the difficulties associated with the cross-border distribution of investment funds. The proposed measures consist of amendments to the AIFMD, EuVECA and EuSEF rules. The amendments are intended to harmonise the definition of “marketing” within the EU, thereby reducing the cost of cross-border distribution and fostering competition.
The Commission notes that EU funds are at present significantly smaller than their US counterparts, which hampers their ability to benefit from economies of scale and may negatively affect their returns. It also observes that EU investment funds are still largely confined to their discrete national markets: 70% of all assets under management are controlled by investment funds unregistered for sale in any EU state except their own (and this statistic will surely worsen once UK-managed funds are no longer included).
The initial draft directive amending the AIFMD also sought to introduce a new definition of “pre-marketing“, with the aim of resolving the present uncertainty as to what constitutes marketing under the regime.
The purpose of the accompanying regulation is threefold: i) to transpose the new pre-marketing definition across to the EuVECA and EuSEF regime; ii) to introduce new standards of transparency around the rules and procedures governing cross-border distributions of interests in AIFs; and iii) to empower ESMA to collate and make available information about national marketing rules, fees and notifications in relation to AIFs.
The Council of the European Union has recently proposed amendments to these drafts, with the principal objective of amending the definition of pre-marketing initially proposed by the Commission, widely thought within the industry to be unworkable in its original form. The Council’s amended text will now be returned to the European Parliament for a second reading.
Aside from the proposed definition of pre-marketing, the Commission’s intended approach, which has been carried forward by the Council, is to illuminate, rather than eliminate, the differences between the marketing rules of different Member States. This has prompted criticism from several industry stakeholders who argue that the EU’s continued toleration of the divergence of marketing rules across member states is at odds with its professed aim of deepening market integration.
Definition of “pre-marketing”
In the absence of guidance as to the definition of “marketing” under the AIFMD, domestic regulators have to date enjoyed full discretion in their interpretation of its meaning, which has in turn led to considerable regulatory divergence as to how far a fund manager can go in marketing to investors within a given jurisdiction before a passport or registration under the national private placement regime is required. The FCA has adopted the pragmatic view that marketing occurs only upon the circulation of finalised copies of the fund documentation, stating at 8.37.6 of PERG that “any communications relating to…draft documentation do not, in our view, fall within the meaning of an ‘offer’ or ‘placement’ for the purposes of AIFMD“. The circulation of drafts, clearly labelled as such, to UK investors will not constitute AIFMD marketing and therefore fall outside the scope of the AIFMD passporting / registration requirements in the UK (but not outside of the UK financial promotion rules). Some other Member States take the view that distribution of marketing material will constitute ‘marketing’ in all circumstances once the vehicle constituting the AIF has been established.
The proposed rules aim to end such divergence by standardising the definition of pre-marketing, and, in so doing, that of marketing. Its purpose is to clarify the steps a manager can take to promote a fund without triggering a formal registration or passport application.
The Commission’s initial proposals defined pre-marketing as:
“…a direct or indirect provision of information on investment strategies or investment ideas by an AIFM or on its behalf to professional investors domiciled or registered in the Union in order to test their interest in an AIF which is not yet established.”
This pre-marketing safe harbour would apply only to authorised EU AIFMs and not to non-EU managers. It is not clear whether the Commission intends to rectify this situation or whether it proposes to continue with this regulatory divergence. The draft pre-marketing rules do not recognise any distinction between the marketing of EU and non-EU AIFs, stating only that they will apply to “authorised EU AIFMs”. The pre-marketing safe harbour would therefore apply to both EU AIFs and non-EU AIFs, so long as either is being marketed by an EU AIFM. However, since the proposals do not (in their accompanying notes or otherwise) explicitly address this point, it remains unclear whether the inclusion of non-EU AIFs was intentional.
As initially drafted by the Commission, the pre-marketing safe-harbour would have been limited to situations where the relevant AIF had not already been established, the documentation provided to investors did not enable them to subscribe to the AIF, and the documentation provided did not amount “…to a prospectus, constitutional documents of a not-yet-established AIF, offering documents, subscription forms or similar documents whether in a draft or a final form allowing investors to take an investment decision.” Essentially this would have meant that where a fund had been established, any information it provided would not have fallen within the pre-marketing safe-harbour and it would therefore have been required to comply with all relevant passporting or registration requirements applicable to the jurisdiction in which prospective investors were based.
However, the Council’s recent compromise proposal would see this definition considerably amended so that a manager may conduct pre-marketing in respect of an AIF which is already established but not yet notified for marketing in a given member state, and allowing for the circulation of constitutional documents, a prospectus or offering documents in draft form (but not subscription documents, whether in draft or final form) before marketing is deemed to have occurred.
The Council’s compromise proposal also stipulates that where a draft prospectus or offering documents are provided, in order to constitute pre-marketing these “…shall not contain all relevant information allowing investors to take an investment decision and shall clearly state that: (a) the document does not constitute an offer or an invitation to subscribe to units or shares of an AIF; (b) the information presented should not be relied upon because it is incomplete and may be subject to change.” If adopted this compromise proposal would bring the pan-European rules more in line with current rules in the UK. The proposal is generally considered amongst the industry in the UK to be an improvement on the initial draft proposals from the Commission. The rules would also better align with current FCA procedure, which requires fund documents submitted in support of passport applications to be in final form.
There is currently considerable divergence between national regulators around the fees and regulatory hurdles they impose in connection with the exercise of the AIFMD marketing passport into their jurisdictions. Some jurisdictions impose charges, others (including the UK) do not. Some apply more onerous ‘gold-plated’ marketing rules of their own; others demand only that the minimum requirements of AIFMD be met. In the absence of any central databases setting out the fees and regulatory hurdles applicable to each jurisdiction, it is not always easy for fund managers to work out the costs involved in the cross-border marketing of AIFs.
The current proposals, as amended by the Council in its compromise proposal, contain a number of measures aimed at resolving this uncertainty. They include a requirement that any fees or charges be consistent with the overall operational cost borne by the domestic authority in performing its administrative role, as well as imposing a duty on domestic authorities to assemble: (a) a public website detailing the laws and regulations applicable to AIFMs marketing within their borders; and (b) a public website setting out their domestic fees and charges. In each case, the domestic authority would be required to notify ESMA of such information and in turn, ESMA would collate this information into two publicly accessible central websites.
In addition, under the proposals, fund managers marketing under AIFMD would be required to ensure that marketing communications to investors are identifiable as such, present risks and rewards in a balanced way and are “fair, clear and not misleading“. The proposals would also entitle domestic authorities to request sight of the marketing communications to be provided to investors, in order to confirm that they comply with the foregoing requirement, as well as any national marketing requirements (although this may not constitute a prior condition for marketing). Once again, this would create further scope for regulatory disparity between Member States: inevitably, some domestic regulators would take a much more hands-on approach than others.
Despite their laudable aim of bringing clarity to cross-border marketing within the EU, the original proposals from the Commission left much room for improvement. The compromise proposal recently published by the Council goes some way towards resolving this, particularly in its more pragmatic approach to pre-marketing. However, whether this will achieve its intended purpose of encouraging cross-border distribution remains to be seen, and room for divergence on a state by state basis remains.
The attempt to increase transparency should be welcomed (especially since domestic authorities and ESMA would shoulder the bulk of the attendant administrative responsibilities). However, the new provisions explicitly recognising the entitlement of national regulators to charge managers (albeit proportionate) fees, may well result in those regulators who did not previously impose charges and fees for activating and maintaining the marketing passport, deciding to do so.
Criticism along these lines has featured prominently in the response from industry. The recently published response of the City of London Law Society emphasised the need to both extend and clarify the scope of the proposed definition of pre-marketing, and queried whether continued allowance of regulatory divergence amongst Member States vis-à-vis rules and fees is compatible with the Commission’s overriding objective of fostering marketing integration.