Good news at last

Private equity fund managers based outside Europe breathed a sigh of relief when the European Parliament finally decided that they may be entitled to a fund “passport”, enabling them to market alternative investment funds throughout the EU. In November, the European Parliament voted to adopt the text of the directive on alternative investment fund managers agreed in October following months of negotiation among the European Parliament, the EU Council and the European Commission.

The negotiated compromise extends the fund “passport”, the ability to market alternative investment funds to investors in the EU using a single notification procedure, to non-EU managers, but only after a two-year waiting period, and only if the European Securities and Markets Authority (ESMA) advises the Commission that extending the passport is appropriate.

The directive is due to enter into force by mid 2011 and will then have to be implemented by member states within two years – by mid 2013. It will have a profound impact on the management and marketing of private equity funds in the EU and impose significant increases on the compliance costs of funds and their managers.

The directive will apply to all EU managers (managers with a registered office in the EU) that manage one or more funds, and non-EU managers that manage one or more funds established in the EU or that market one or more funds (wherever established) in the EU.

There is a limited exemption for EU managers with combined assets under management of less than €100 million (€500 million in the case of funds that are not leveraged and have no redemption rights exercisable for a period of 5 years from initial investment). However, these managers will still need to be registered in their home states and will not be able to benefit from any of the rights under the directive unless they elect to comply with it.

Once the directive is implemented, an EU manager will need to be authorised by its home state regulator in order to be able to manage and market funds. Authorisation will involve significant compliance and reporting obligations. However, once authorised, an EU manager will be able to market the EU funds that it manages to professional investors in its home state, and in other member states, following a single notification procedure, rather than having to comply with multiple EU private placement regimes.

A non-EU manager proposing to manage EU funds or market funds in the EU will not be able to apply for authorisation (or market funds using a passport) until the commission extends the passport to non-EU managers. This will not occur until 2015 (at the earliest), two years after the directive is implemented, provided that the commission receives a favorable opinion on the extension of the passport from ESMA. Until then, non-EU managers will be able to continue marketing their funds to investors in the EU under national private placement regimes. However, once the directive is implemented, certain minimum conditions will apply:

• non-EU managers will have to comply with the directive’s disclosure and (if relevant) portfolio company requirements;
• appropriate cooperation arrangements will have to be in place between the regulator of the member state where the fund is to be marketed and each of the non-EU manager’s regulator and, in the case of a non-EU fund, the regulator of the non-EU fund; and
• the country where the non-EU manager or the fund is established must not be listed as non-cooperative by the Financial Action Task Force (FATF).

Approximately three years after the commission extends the passport to non-EU managers and funds (assuming it does so), the commission will decide when private placement regimes are to end, after which the passport will be the only means of marketing funds to EU investors.

Non-EU managers who wish to become authorised once they are able to do so (i.e., from 2015) will need to apply to their “Member State of reference” – generally, the member state where the manager intends to market its funds or, in the case of a manager proposing to manage an EU fund, the member state where the fund is established. Authorisation will involve full compliance with the provisions of the directive, and:

• appropriate cooperation arrangements will have to be in place between the manager’s regulator and the regulator of the member state of reference;
• the manager’s home jurisdiction must not be listed as non-cooperative by FATF, and must have signed an OECD compliant tax treaty with the member state of reference; and
• the laws, regulations and administrative provisions of the manager’s home jurisdiction must not prevent the effective exercise by regulators of their supervisory functions under the directive.

In addition, a non-EU manager will have to appoint a “legal representative” in its member state of reference to act on its behalf in relation to its obligations under the directive.

The directive contains only limited transitional provisions. For non-EU managers, the provisions that might be relevant are:
• Managers that manage closed-ended funds before the directive is implemented (i.e., in 2013) that do not make any additional investments after the implementation date may continue to manage those funds without being authorized.
• Managers that manage closed-ended funds with subscription periods that close prior to the entry into force of the directive, and where the fund life is not intended to continue more than three years after the implementation date (i.e., beyond 2016), may continue to manage those funds without applying for authorization or complying with the directive, except for the disclosure and, if relevant, portfolio company requirements.

Managers should begin now to consider whether any changes will be required to the management and marketing of their funds in order to ensure that appropriate arrangements are in place in respect of the Directive. In particular, non-EU managers that manage or propose to manage EU funds should consider whether the transitional provisions will allow them to continue to do so after the Directive is implemented in 2013.