When the European Securities and Markets Authority (ESMA) created the Alternative Investment Fund Managers Directive (AIFMD), it allowed EU alternative investment funds managers access to a European passport to market and manage EU alternative investment funds across all member states. However, it denied this benefit to non-EU AIFMs.
Until ESMA extends the marketing passport to non-European fund managers, including managers in the US, Cayman Islands, Japan and the five other countries that ESMA is expected to assess by June 30, they can continue fundraising in specific European countries in accordance with each country’s National Private Placement Regime (NPPR).
Under these regimes, managers must comply with certain AIFMD requirements and any additional conditions imposed by national law in the investor’s home jurisdiction.
NPPRs will be in place until the passport becomes available to managers from different “third countries”, when they might be phased out. However, progress on introducing such a passport remains slow, with the original 2015 deadline set out in the directive missed, according to Invest Europe, the European association representing private capital.
Despite the benefits of private placement regimes, the current NPPR process can be “more costly than you think” and rules out placement in certain countries, says Manuel Lorenz, partner in the capital markets practice at Baker & McKenzie.
Fund managers trying to market to investors in countries that have opted not to have a NPPR, such as Germany and France, are required to appoint a “depositary-lite”. This means that the non-EU manager must appoint one or more entities to carry out the following functions in respect of the fund being marketed: safe custody, cashflow monitoring, and oversight.
In order to market under the NPPR, managers must also satisfy a number of conditions, as detailed in regulations 57, 58 and 59 of the directive. Some of these include disclosure to investors, continued reporting to regulators, the preparation of an annual report and certain restrictions on asset stripping, and “material change notifications”.
Before deciding to market in Europe, fund managers should consider the benefits and challenges of being fully authorised under AIFMD compared with accessing investor capital through NPPRs.
Here are the top tips our sources suggest to assess which is right for your firm.
1. Draft a business plan
Firms becoming authorised under AIFMD for the first time need to apply to their home regulator, for example the Financial Conduct Authority (FCA) in the UK. However, the application can take time to draft and receive approval, and is not straightforward. The most significant aspect of the application process is drafting a business plan, says Grant Lee, asset management partner at PwC.
In order to save time and reduce burdens, firms should have a regulatory business plan in place, adds Lee. This includes being clear throughout the application about how the firm’s track record articulates how its approach and style will be beneficial to investors, and its competitive advantages. Another key point is governance: do the directors have relevant and sufficient experience and is the head of risk management at the same level as the head of portfolio management?
2. Implement independent processes
Traditionally, private equity fund managers have performed risk management tasks within their portfolio management function. However, AIFMD requires managers to implement independent risk management and document the process.
Firms need to have risk management in place, and effective systems that can answer any queries about how the investment strategy is executed by portfolio managers, how the risk management function is independent from the portfolio management function and what portfolio management information is to be analysed by the risk management function, says Lee.
3. Consider NPPR complications
If the firm holds no AIFMD license and wants to place funds through NPPRs, managers need to consider how many prospective subscribers they will have in each country. More often than not, a small number will not warrant the cost of registration and compliance in the “difficult” countries, says Lorenz.
Marketing under NPPR can be complicated due to the number of EU member states and regulatory bodies, each with their own requirements. Seek advice on the conditions for each jurisdiction before starting marketing efforts, says Lee.
4. Decide on necessary member states
Each member state also has its own interpretation of marketing – some are much stricter than others. In the UK, for example, the NPPR notification is a straightforward process. There’s a link on the FCA website and once the notification form has been completed an automated reply should follow 48 hours later. It is not necessary to wait for the automated reply before marketing. The date of the submission of the NPPR marks the start of the ongoing obligations, most notably reporting under AIFMD.
In order to make this process easier, fund managers should be clear about the member states they need to access to raise capital, says Lee. Notifying unnecessary member states will trigger ongoing requirements which may outweigh the capital raised in that jurisdiction, particularly because you will need to submit individual regulatory reporting to each member state you have notified, he adds.
5. Use reverse solicitation correctly
Many managers use reverse solicitation as a marketing method. Under AIFMD, it refers to investment in funds by EU investors on the exclusive initiative of those investors.
However, using reverse solicitation as a marketing method is not a strategy, warns Lorenz. Simply having the subscriber sign a confirmation that he contacted the fund manager first is not sufficient if the circumstances are not properly documented, he adds.
Creating a paper trail to show that the investor contacted the manager first via email to prove that the manger has complied with the exemption is also often not enough, says Lorenz. They should provide more detailed information about why the investor contacted the manager about the fund.
Firms also need to install compliance procedures that make sure that placement agents, for example, are not doing anything untoward.
6. Beware of anti-asset stripping rules
Article 30 of AIFMD imposes asset-stripping provisions on funds acquiring portfolio companies. Under these rules, the manager of an alternative investment fund is heavily restricted in the first two years of control of most companies in its ability to extract assets from that company by way of distributions, capital reductions, share redemptions and buy-backs.
One of the conditions under NPPR is that the fund manager is compliant with these rules. Non-EU funds need to be aware of these rules, which may significantly restrict the fund’s ability to restructure portfolio companies or increase leverage to make a recapitalization, says Lorenz.
7. Understand your tax position
Tax authorities are increasingly using data analytics to identify at-risk transactions or companies. Recent agreements between tax authorities and regulators to share more data need to be taken into consideration.
Firms need to understand the implications of this, says Lee, and have a data management strategy in place to ensure that any information reporting under AIFMD is consistent with other sources of information, such as reporting on investor tax attributes under the Common Reporting Standard.
Deal teams also need to be aware that tax authorities are increasingly challenging managers that travel to their jurisdictions for the purposes of meeting investors or originating and negotiating deals over whether these activities create a taxable presence (or permanent establishment), says Lee. The recognition of a permanent establishment can result in not only additional income taxes and penalties for the manager, but may also result in payroll tax and VAT liabilities.
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