This story is sponsored by MUFG Investor Services
As the economic effects of the pandemic ripple in multiple directions, we asked David Rochford, MUFG Investor Services’ head of private equity, real assets and hedge funds, and Cliodhna Murphy, the firm’s executive director of product development, what US managers looking at setting up a European vehicle need to know.
What’s the first priority for US managers looking to expand in Europe?
David Rochford: The first thing a manager needs to consider is where they plan to raise capital. Managers interested in marketing across Europe and setting up a pan-European structure or a fund over a certain size threshold have a number of choices but, generally speaking, Ireland and Luxembourg take the lion’s share of new fund set-ups. Although they both sit under the Alternative Investment Fund Managers Directive and share the same oversight through the European Securities and Markets Authority, it’s important to explain to managers the nuances between jurisdictions.
In recent times, Luxembourg has attracted a lot of capital, particularly for the private equity market. This is because Luxembourg offers both regulated and unregulated LP solutions depending on the needs of the manager and its investors. Ireland is struggling to keep pace and this is unlikely to change until it passes its new Irish Limited Partnership law, which will make it a more competitive domicile. If a manager is looking at tapping investors from one specific European country, then they need to assess the flexibility of the marketing rules in that jurisdiction, the national private placement regime, and whether that solution works for the size of their fund.
The AIFMD regime is far-reaching. What are the key things managers need to know?
DR: We spend a lot of time explaining the complexities of AIFMD, in particular the responsibilities played by each of the key parties: the management company, depository and fund administrator. In Luxembourg, the available options include the manager (AIFM) being regulated while the fund – typically a RAIF (reserved alternative investment fund) – is not. This is a familiar structure to US managers. But they need to get clear on the management company obligations – for instance, regulatory compliance, delegated oversight, risk management and distribution – and understand that the depository role is to ensure assets are kept in good title and that they need an administrator to keep accounts and records. This might be entirely new to them.
Once they’ve selected the jurisdiction and are familiar with AIFMD, what comes next?
DR: Engaging a lawyer to manage the document process and interacting with the regulator as well as service providers to establish the fund structure. Then comes appointing service providers to act as the management company delegates in charge of the core functions: investment management, administration and distribution. Larger US managers that already have a presence in Europe would have appointed existing service providers to conduct these activities. But many US managers typically undertake administration work in-house and aren’t used to the complexity involved in using third parties. Generally, they don’t want the headache of co-ordinating multiple providers and love the idea of a platform solution that services all these requirements. From our perspective, as the impact of covid plays out, the more supportive we can be of our clients, the better. Funds in general want more from their asset servicer. Of increasing significance is access to data and the technology to collect, aggregate, analyze and report it in a meaningful way that provides transparency.
What other issues come up with US managers?
DR: A big one is Brexit. During the pandemic, the negotiations between the UK and EU appear to have taken a backseat, but they will resume. Will there be a deal? And how will that play out in terms of manager access to capital? US managers want that process to be as easy as possible and not to face additional requirements or costs relating to the jurisdiction of the fund. A no-deal scenario, looking more likely, would mean US clients targeting the UK, and the EU would have to establish different vehicles for UK and EU investors. It would open up real concerns and additional costs. For instance, the European Securities and Markets Authority recently completed a review of AIFMD and one of the key points raised was delegation. ESMA wants to ensure the management of European AIFs is subject to the same regulatory standards. If there is delegation to third countries (eg, the UK) can they be effectively managed?
Within the EU, is there anything pending on the regulatory front that US managers should be aware of?
Cliodhna Murphy: In the European context, the principal one is the EU regulation on sustainability-related disclosures, which is due to come into force in March next year, and the Taxonomy Regulation, which will apply from January 2022. The taxonomy refers to the common language around environmental factors and characteristics that will enable firms and investors to identify what activities are sustainable. In its current form it includes 50 data points that would apply to private equity.
The EU Disclosure Regulation outlines the information managers need to update on their website, such as policies and the integration of sustainability risks into their investment decision-making processes; information on how remuneration policies are consistent with the integration of those risks; and a statement regarding their due diligence policy that considers the adverse impacts of investment decisions on sustainability factors. At the product level, in the prospectus, managers will need to disclose the impact the product will have on sustainability factors; explain disclosure on environmental, social and governance integration; and the impact on returns.
That’s a lot more reporting. Overall, how receptive have your clients been?
CM: Very receptive. In isolation, managers may find it difficult to decide what information to collect from a portfolio company and which standard to adhere to, and that’s a key area of focus for us. They will need to work with specialists to gather the granular-level data required about, for instance, carbon emissions and footprints and energy consumption. We can assist them with finding appropriate experts to source the various data points and then help categorize that information, provide independent verification and reporting, as well as facilitate collaboration between GPs and LPs. Part of this shift to increased ESG disclosure is investor-driven. They want to see more sustainability-related disclosures to avoid green-washing. We can provide them also with independently prepared and verified ESG transparency reporting.
Are managers prepared for these new requirements?
CM: I would say at present not that prepared. The EU disclosure regulation should be the initial focus – that has been more clearly defined, as the taxonomy and the regulation is still evolving. We are engaging with our clients and industry bodies to provide feedback to regulators about what data to collect and how it can be standardized. One potential initiative I find very interesting is that the EU is considering making what managers report publicly available, which would be very beneficial for ESG transparency. With US managers specifically, any additional requirements are always a concern. But if they want to market into Europe, they will have to start preparing for these regulations.
Longer term, what impact will these new ESG disclosure rules have?
CM: Once these regulations are finalized, we see a huge opportunity for managers to launch new products that clearly disclose their ESG impact, dispel investor concerns about green-washing and subsequently attract LPs. Where the EU is leading, other regulators aren’t going to be too far behind. The US Securities and Exchange Commission has already started to make positive noises about new sustainability disclosures.