In the past, there has been no legislation at a European level in relation to private equity funds; that is, no EU legislation or regulation applicable throughout the EEA. This is because the existing European legislation that regulates funds – UCITS – relates to retail funds. UCITS was, in fact, the first European legislation giving a cross-border ‘passport’ of any kind in the financial sector beyond the basic Treaty rights. It defined a particular narrow class of funds which could, subject to compliance with the UCITS Directive requirements, be promoted to the retail public across Europe. While the UCITS Directive has been subject to several rounds of amendment, it remains the case that private equity funds do not qualify as UCITS. This is mainly because they invest principally in unlisted securities, which are not regularly exchange-traded, although also because they are rarely, if ever, open-ended with regular NAV issues and redemptions of units.
Moreover, the EU ISD and its successor, MiFID, deliberately excluded from their scope collective investment undertakings and their managers and depositaries. The regulation of private equity funds and their managers was therefore left to national regulation. The relevant national regimes vary widely, for example, in the UK the funds themselves are unregulated but their managers are subject to full regulation by the FSA and there are special restrictions on marketing. In contrast, in some other countries only regulated funds are permitted and both the funds and their managers are subject to regulation, while other countries do not currently regulate the sector at all, at least not to any significant degree.
As mentioned above, from a UK perspective the impact of MiFID on private equity funds was relatively limited as much of the industry is structured in order to rely on the manager/operator exemption from MiFID but is nevertheless subject to FSA regulation. Managers/operators benefit from a lower capital requirement than would apply to those subject to MiFID, the CAD (or CRD) and some other minor variations to the FSA rules but, so far as it considered appropriate, the FSA made its rules consistent for both MiFID and non-MiFID firms.
MiFID had a more significant impact on funds employing an advisory structure because, unlike the ISD which did not directly regulate investment advice but only investment management, MiFID brought with it the pan-European regulation of advisory structures. While investment advice was already regulated in the UK, this was not the case in many other European jurisdictions. However, there remain many national variations. While it is clear that MiFID will apply to all investment services and activities carried out in relation to financial instruments, there is still scope for certain jurisdictions – notably Germany – to take the view that the term ‘financial instrument’ excludes a number of types of private equity investments where the jurisdiction concerned does not regard them as transferable securities. Moreover, a number of advisory structures can take advantage of sub-advisory and group structures to limit the application of MiFID.
This is the background against which the AIFMD has been proposed. It is not so much a gap in European regulation as a patchwork of national regimes of greater or lesser severity and complex interactions. Furthermore, and this may well prove to be the case for the AIFMD as well, even where advisers and discretionary managers of private equity investments are potentially subject to MiFID, there is significant variation in the application of that Directive across the various EEA jurisdictions.
In addition to the AIFMD, which is covered in more detail in subsequent chapters in this publication, there is a host of other regulatory developments that will pose challenges to private equity fund managers operating in Europe (see Figure 1.1 for a timeline illustrating some of the key developments in this regulatory landscape). Even without addressing the regulation beyond the financial services sector (such as bribery and anti-corruption legislation) and proposals which are at a very early stage, such as ‘shadow banking’ regulation, almost every aspect of EU financial sector regulation is in the course of being rewritten. Not all of these changes will have a direct impact on private equity fund managers but it is likely that there will be various indirect effects that may not have been fully considered by the legislators.
A key high-level change is the evolution of the EU regulatory framework with the creation of the three ESAs; the most relevant of which for private equity is ESMA. In and of itself, this is not something that will necessarily impact the industry but it does represent a shift towards concentrating more power at EU level, with the ESAs’ brief to create a single EEA rulebook and powers to give guidance, and even intervene directly in supervisory matters in some circumstances. Further, since the ESAs will operate by qualified majority voting, there is a very real danger that the insight and understanding built up in those parts of the EU with an active private equity funds industry may be lost in the move to add greater European control of the regulatory process.