The EU Commission on 12 March 2018 issued proposals for a new Directive and new Regulation intended to “boost the cross-border market for investment funds” and “eliminate current regulatory barriers to the cross-border distribution of investment funds in order to enable a better functioning Single Market and economies of scale”. It is unlikely to surprise anyone who has been involved in the long-running saga of implementation of the Alternative Investment Fund Managers Directive (AIFMD) to discover that the provisions of the new draft legislation are likely to be seen by fund managers as further restricting, rather than liberalising, their ability to market and raise money across the EU.
Authors: Tim Dolan
Key provisions of the new draft legislation as it applies to alternative investment fund managers (AIFMs) and their funds (AIFs) include:
- A new, very restrictive, definition of pre-marketing which impliedly changes the type of marketing for which regulatory advance notifications and approvals are required.
- New obligations applying to all marketing communications.
- Restrictions on the circumstances in which an AIFM can give notice that it has ceased marketing in an EU jurisdiction, including a new obligation to offer to buy out any investors in that jurisdiction before such a notice can be given.
- Express confirmation that national regulators can levy fees and charges in relation to cross-border marketing.
- New obligations to maintain payment and information provision facilities in any Member State in which an AIF is marketed to retail investors.
- Express confirmation that national regulators can require AIFMs to submit all their marketing material for approval if they market to retail investors.
- More information to be held centrally by the European Securities Markets Authority ESMA.
The new rules would require Member States to allow EU AIFMs to carry out pre-marketing and prevent them from requiring notification in advance of pre-marketing activities. That sounds good in principle but the Commission limits the definition of pre-marketing to the “direct or indirect provision of information on investment strategies or investment ideas” to EU professional investors “in order to test their interest in an AIF which is not yet established”.
Specifically excluded from permitted pre-marketing is any situation where the information presented:
- relates to or contains reference to an established AIF;
- enables investors to commit to acquiring units or shares of a particular AIF; or
- amounts to a prospectus, constitutional documents of a not-yet-established AIF, offering documents, subscription forms or similar documents, whether in a draft or final form, allowing investors to take an investment decision.
Substantially the same provisions on pre-marketing are proposed to be inserted into the EU regulations governing venture capital and social entrepreneurship funds (EUVECAs and EUSEFs, respectively).
This description of pre-marketing would clearly prevent any marketing taking place after a fund is formed, even if it is only in a preliminary format. It would also clearly outlaw the practice currently carried on in a number of Member States, and expressly permitted by FCA guidance in the United Kingdom, which allows pre-marketing to include discussion and negotiation of draft documents provided that they are clearly only draft and it is made entirely clear that there is no opportunity to subscribe for, offer or commit to acquiring interests in the AIF and that there will be no such opportunity unless and until AIFMD marketing approval is sought and obtained. That approach is based on the main definition of ‘marketing’ in the AIFMD, which requires there actually to be an “offering or placement” of the interests; and also on the practicalities of obtaining AIFMD marketing approval, which requires the submission of full constitutional and marketing documents even though these are often only prepared at a later stage.
The new approach would, it seems, effectively change the definition of marketing by the back door and require full documentation to be approved in advance by the regulators even when it will inevitably be subject to extensive negotiation and amendment resulting in material changes, which would require further regulatory clearance.
Since all of these provisions relate only to communications with professional investors and only to EU-authorised AIFMs, which are fully subject to the AIFMD and will have to obtain regulatory approval before any offer is actually made of interests in an AIF they manage, it is hard to see what investor protection benefit is gained by imposing these restrictions on pre-marketing. Nevertheless the draft is entirely clear not only that there can be no pre-marketing of an AIF once it has been established, but also that no offering documents, even in a draft form, can be distributed to investors.
The new proposals are unclear in a number of other respects. For example, it is unclear whether:
- The exclusion of information which “contains reference to an established AIF” means that pre-marketing must avoid track-record information relating to other funds.
- Pre-marketing information about a proposed (but not yet established) feeder fund or fund of funds is banned from referring to an already established master fund or possible investee funds.
- Pre-marketing material must be limited to “investment strategies or investment ideas” relating to the types of investment which the AIF would make or whether “investment ideas” can extend to outlining the proposed structure and terms of the trust. In other words, can pre-marketing include a term sheet or will that be banned? Particularly problematic in this context is the use of the words “allowing investors to take an investment decision”. In other contexts these have been used to pick up any communication which has sufficient data in it to allow an investor to make a decision in principle to invest.
The draft goes on to say that if professional investors invest in an AIF which is formed following permitted pre-marketing, or invest in an AIF managed or marketed by an EU AIFM which engaged in pre-marketing an unestablished AIF with similar features, that will be considered to be the result of marketing. In other words, you cannot use permitted pre-marketing as a technique to generate an ‘own initiative’ approach by the investor so that you can completely avoid AIFMD marketing rules. This is underlined in a draft recital which says that when an AIFM offers interests in an AIF “with features akin to the pre-marketed investment idea, the appropriate marketing notification procedure should be observed and the AIFM should not be able to invoke reverse solicitation”.
That regulatory approach is unsurprising – once there is pre-marketing (or in UK terms, financial promotion) by the AIFM it is hard to see that any subsequent purchase is made wholly at the investor’s ‘own initiative’. Indeed, the wording is mildly helpful in that it tends to indicate that an ‘investment idea’ can include certain ‘features’.
However, it introduces more uncertainty, notably around:
- What happens when the pre-marketing information was itself only provided because the investor requested it of its own initiative.
- What happens when the AIF in which investment is made has some features which are similar to those appearing in pre-marketing material and others which are very different.
- Whether it matters if the investor concerned received pre-marketing material. Logically, this should be critical but it is not stated.
The draft Regulation states that “to safeguard investors’ protection and secure a level playing field between AIFs and UCITS the standards for marketing communications should therefore equally apply to marketing communications for AIFs and UCITS”.
Equating the marketing rules for AIFs with those applicable to UCITS is a very major shift. UCITS are open-ended investment funds investing in liquid securities and expressly formed and approved for marketing to retail investors across the whole of the EU, whereas the AIFMD only permits marketing to professional investors, with any distribution to retail investors remaining a matter for domestic national law, and covers all other types of investment fund, both open- and closed-ended, whatever asset class they invest in.
Traditionally a regulatory distinction has always been drawn between communications appropriate for professional investors and those appropriate for retail investors. For example, under the PRIIPs Regulation a highly prescriptive key information document (KID) must now be prepared and provided whenever a fund is made available to retail investors, but not if it is only available to professionals.
Recent changes to regulation under MiFID II have, however, tended to apply to the professional market rules previously only applicable to retail investors. These proposals continue that trend.
The draft regulation tracks MiFID II wording by requiring that:
- All marketing communications are identifiable as such.
- Risks and rewards of purchasing interests in an AIF are presented in an equally prominent manner.
- All information contained in marketing material is fair, clear and not misleading.
- Specific information about the AIF contained in any marketing communication which comprises an invitation to purchase interests must not contradict or diminish the significance of the information required to be disclosed to investors under the AIFMD.
It adds that ESMA can issue guidelines on the application of these requirements, taking into account online aspects of marketing. There is therefore a real risk that further detailed requirements will be imposed on similar lines to MiFID II and/or the PRIIPs Regulation, for instance on the presentation of track records. Even if nothing more is imposed (which seems unlikely), firms may well find that giving equal prominence to risks and rewards and avoiding diminishing the importance of the AIFMD-required disclosures is more difficult than they expect. Some may have to restructure or significantly amend their PPMs. More will have to vet their other marketing material much more extensively than has previously been the case.
The AIFMD is currently unclear on how and when a firm can give notice that it is no longer marketing a fund. Most firms have taken the view that it is a question of fact whether they are still marketing in a jurisdiction and that they can at the very least give such a notice once the fund has had its final closing and it is no longer possible to subscribe for interests in it. As EU AIFMs, they continue to be obliged to comply in full with the AIFMD in managing and reporting on each fund, whether or not it is still being marketed.
The new draft legislation would make it much more difficult to put a formal end to marketing in a jurisdiction – which is likely to mean that firms will need to think much more carefully before giving a marketing notification, despite the new limits on the scope of pre-marketing. It says that an EU AIFM will only be allowed to cease marketing an EU AIF in a Member State where it has given a marketing notification if all the following conditions are satisfied:
- either no investor domiciled or registered in that Member State holds interests in the AIF or no more than 10 such investors hold interests representing less than 1 per cent of the assets under management of that AIF (though oddly phrased, this appears to mean there must be no more than 10 investors in the country and they must between them hold less than 1 per cent of the fund);
- a blanket offer must be made publicly and addressed individually to all known investors in the relevant country to repurchase, free of any charges or deductions, all the AIF interests held by investors in the Member State; and
- the intention to stop marketing in the Member State must be made public in a publicly available medium which is customary for marketing AIF and suitable for a typical AIF investor.
Even if these conditions are satisfied and marketing ceases, any remaining investors must still continue to be provided with the information required for regular investor reporting under the AIFMD.
These conditions, if ever appropriate (which is unclear), seem designed more for a publicly marketed open-ended fund than for most AIFs. It is not clear why any further conditions need apply when there are no investors in the jurisdiction. Nor is it clear why a closed-ended fund which has closed should be obliged to make a repurchase offer. Many will not have the power to do so. Even if they have the necessary power, offering to repurchase the interests of investors in one jurisdiction could disadvantage other investors and involve treating them unfairly. Questions may arise over whether doing so might in some circumstances make the fund open-ended or require a takeover offer. It is also hard to see why a publicly advertised termination is required for marketing which has only been conducted privately, as is normal for most AIFs.
While the AIFMD gives no ‘passport’ for EU-wide AIF marketing to retail investors and leaves full power to Member States to restrict such marketing as much as they wish, the new proposals will impose some minimum requirements for any state which is willing to permit retail marketing.
AIFMs will be obliged to establish in each Member State where they intend to market to retail investors facilities to:
- Process subscription, payment, repurchase and redemption orders
- Provide information on handling those orders and paying repurchase and redemption proceeds
- Facilitate the handling of information on the exercise of investors rights
- Make the fund constitutional documents and most recent annual report available for inspection and the provision of copies
- Provide information in a durable medium on the tasks carried out by these facilities
These tasks must either be done by the AIFM itself or by a third party which is engaged by a written contract and is subject to regulation governing the tasks performed. It is expressly stated that the AIFM shall not be required to have a physical presence in the relevant Member State, so that these new facilities can be provided online. Arguably, the fact that these express provisions are made in relation to facilities for retail investors also reconfirms that Member States should not impose extra requirements of this kind when marketing is only to professional investors.
The serious problem with these new provisions is a requirement that the tasks must be performed “in the official language or official languages of the Member State where the AIF is marketed”. This means that it will not be worthwhile to permit even the most limited marketing to retail investors in any Member State unless the AIFM is ready to provide fully translated documents and a functioning website, or other facility, operating in all the official languages of the relevant state. It will no longer be sufficient just to use a “language customary in the sphere of international finance” (Eurospeak for English, with some flexibility to use others).
This is disappointing.
In the EU the line is drawn between retail and professional investors in a way which excludes most high-net-worth individual investors (HNWIs) from being classified as professional. Even local authorities are no longer automatically classified as professional.
Coupled with the PRIIPs Regulation, these new provisions are likely to mean even fewer funds being made available to investors who cannot be classified as professional under the MiFID II tests. Even the most limited and targeted marketing to appropriate ultra-HNWIs will bring with it extensive additional regulation designed for the mass market.
Moreover the draft Regulation also provides that if a Member State allows AIFMs to market to retail investors in its territory, the relevant authorities in that Member State may also require the AIFMs to notify them systematically of all marketing communications which the AIFMs plan to use directly or indirectly in their dealings with investors. Local regulators are not obliged to require this, and cannot make it a pre-condition for marketing in their jurisdiction. However, if they do require pre-notification of all marketing communications, they have up to 10 clear working days to notify the AIFM if they want a marketing communication amended.
Any Member State which imposes such a pre-vetting of retail marketing communications must give information on the relevant procedures on its website (though the language to be used is not specified) and ensure transparent and non-discriminatory treatment of all AIFs regardless of the Member State in which they are authorised.
Clearly the imposition of a pre-vetting process of this kind on all marketing communications is a major barrier to cross-border marketing, and is much more problematic for limited personalised marketing to selected HNWIs or local authorities than for mass marketing.
It is particularly unfortunate that even after the EUVECA and EUSEF Regulations recognised that some types of retail investor can reasonably be treated differently from others, no attempt has been made in the new proposals to broaden this approach and improve the functioning of the capital market for sophisticated HNWIs wishing to invest in a broader range of funds.
In a number of respects the interaction between the new proposals and the marketing of EUVECAs and EUSEFs to the limited class of retail investors they are allowed to approach is unclear. It seems, but is not entirely clear, that:
- They will definitely all be subject to the new rules on pre-marketing as these are to be inserted in the EUVECA and EUSEF Regulations.
- They are all likely to be subject to the new rules on marketing communications and may be required to submit retail communications for pre-vetting.
- Only those who go over the AUM threshold and become subject to the full AIFMD are likely to become subject to the new local language facilities obligation.
- The new rules on cessation of marketing may not apply to them.
What is the impact for non-EU AIFs and AIFMs?
The new provisions on marketing communications and on retail investors appear to apply to all AIFMs. As a consequence, non-EU AIFMs (and EU AIFMs marketing non-EU AIFs) would need to comply with the requirements that such communications are clearly identified as marketing, give equal prominence to risks and rewards, are fair, clear and not misleading, and do not contradict or diminish the significance of required information, together with any subsequent ESMA guidance on marketing.
Local-language dealing, payment and information facilities would need to be provided when marketing to retail investors by both EU and non-EU AIFMs.
Similarly, individual Member States may impose pre-vetting obligations on all marketing communications to retail investors. Non-EU AIFMs might not be protected by the proposed non-discriminatory obligations relating to the exercise of those powers, since the relevant provisions refer only to those authorised in a Member State. Indeed, since discretion is left to Member States on all marketing by non-EU AIFMs at present, a national regulator could insist on pre-vetting marketing communications to professional investors as well if it wished to do so.
The new provisions relating to pre-marketing are specifically inserted in the section of the AIFMD relating to EU AIFMs marketing their EU AIFs. So there will be no EU-wide guaranteed ability for pre-marketing activities relating to non-EU AIFs or by non-EU AIFMs. That will be left to national law, though the likelihood is that there will be a tendency to allow the same types of activity.
The question naturally arises whether, since the relevant provisions apply only to EU AIFMs marketing EU AIFs, a non-EU AIFM might be able to continue to carry out a broader range of pre-marketing activities and/or to treat investor requests following limited pre-marketing as being ‘own initiative’ requests. This seems unlikely. Not only does the relevant recital not distinguish between EU and non-EU AIFMs, but there is also a general principle that Member States should not give third country firms better treatment than EU firms. The draft legislation does not amend Article 42 of the AIFMD (on national private placement regimes for non-EU AIFMs) to refer to the new provisions on pre-marketing at all, but Article 42 does provide that Member States may impose stricter marketing rules on non-EU AIFMs, which tends to confirm that they cannot have laxer rules.
Trickier still is the application of the provisions on ceasing to market in a jurisdiction where a cross-border notification has been given. Again, these have been inserted only in relation to cross-border marketing of EU AIFs to EU AIFMs. But Member States may well take the view that they must impose similar obligations in relation to NPPR marketing notifications.
Some of the new proposals will be more welcome. Time limits of 20 working days and one month have been inserted for regulators to respond to a marketing material change notification rather than there just being an obligation to act “without [undue] delay”, which at least makes the position clearer, even if it can still be an undesirable delay, and one which will more frequently be suffered once the marketing notifications have to be given earlier in the fundraising process. The aligning of requirements for UCITS and AIFs, while generally unwelcome and frequently inappropriate for AIFs, has brought some simplification of the cross-border marketing process for UCITS, for instance by allowing investor facilities to be provided cross-border rather than from a physical place of business in each Member State.
New obligations for regulators to publish their marketing rules and regulations, and related fees and charges, on their websites in a “language customary in the sphere of international finance”, and also provide them to ESMA (which is to provide a publicly accessible website linking through to the underlying materials), should be useful.
Though the opportunity has not been seized to boost the cross-border marketing of funds by banning local regulator fees for such marketing, a new restriction is proposed that any such fees should be proportionate to the expenditure relating to authorisation or registration and the performance of supervisory and investigatory powers under Articles 44, 45 and 46 of the AIFMD. This may give some comfort, but does not protect against those regulators who choose to apply an onerous, and therefore expensive, process.
An interactive tool covering cross-border marketing fees and charges should be useful to help firms decide whether it is worth marketing in different jurisdictions – though not as useful as it would have been to impose a ban on local regulators imposing any such fees and charges in any situation where passported marketing is permitted.
This is just the start of the legislative process. The consultation period closes on 10 May 2018 and feedback can be given through the Commission website on both the Directive and the Regulation. After that it is likely to take some time to finalise the drafts in trialogue between the EU Commission, EU Parliament and Council of Ministers.
Even if this proceeds swiftly and the Directive and Regulation are finalised before the end of 2018 (or at least before March 2019 when Brexit will mean the UK loses its voice in the trialogue) there will be a two-year period from the date of publication for implementing the Directive changes, and the draft Regulation also provides for a two-year period before some of its provisions are implemented (those relating to pre-marketing EUVECAs and EUSEFs, Member States’ obligations to have their marketing rules on official websites and some of the new rules on marketing communications) So the new provisions are unlikely to be fully implemented before 2021.
A slightly surprising statistic contained in the supporting material for the new legislation is that only 3 per cent of EU AIFs are currently registered for marketing in more than three Member States. It is hard to see how the new proposals will improve that percentage – apart from the provisions restricting the power to give notice of cessation of marketing, which may mean that a number of long-closed funds continue to be the subject of marketing notifications.
The new provisions could be amended in the course of consultation and trialogue. As they stand, aspects are unclear or seem likely to worsen, rather than improve, the prospects for EU alternative investment fund raising. But there is no guarantee that any changes made in the legislative process will be helpful.
Moreover there is a significant risk that in countries where the law on pre-marketing is currently unclear, national regulators will in practice start to apply the new interpretations of marketing and pre-marketing immediately.
Client Alert 2018-073