For US private equity firms seeking to do business in Europe, the Alternative Investment Fund Managers Directive (AIFMD) is the most important piece of EU regulation.
Established in 2011, it is an EU law regulating hedge funds, private equity, real estate funds and all other collective investment schemes that do not qualify as traditional investment funds available to retail investors. AIFMD is under review by the European Commission, and PE fund managers wanting to raise capital in the EU need to be aware of forthcoming changes to it.
Because no guidance has been provided by either the European Commission or the European Securities and Markets Authority on the meaning of marketing in the AIFMD, this question has been left up to individual national regulators. Hence, there has been no consistent approach across Europe to the concept of pre-marketing, such as testing potential investors’ appetite for an investment idea or strategy, without triggering a notification (passport) requirement.
With AIFMD under review, the European Commission proposes to define pre-marketing of an alternative investment fund (AIF). This is supposedly intended to address inconsistencies, reduce regulatory barriers imposed by member states’ divergent requirements and boost the market for all kinds of investment funds (one of the goals of Capital Markets Union). It will supersede existing national rules, and this has raised a great deal of concern in private equity. It did not surprise anyone who has been involved in the implementation of the original AIFMD that the new proposal was seen by PE firms as conflicting with current market standards of major European financial hubs, and as further restricting their ability to raise money across Europe.
New pre-marketing regime across the EU
Due to the strong industry reaction claiming that the proposal fell short of its stated objective, the European Parliament and the Council of the EU have prepared a laxer pre-marketing rule proposal that takes a more pragmatic approach and goes up for a vote before EU general elections in May. At first glance, the proposed AIFMD pre-marketing rule now resembles in many ways the approach of the UK’s FCA, Luxembourg’s CSSF and Germany’s BaFin. Each of those regulators’ view is that provision of draft documents is not marketing, provided that such drafts cannot be used by potential investors to make an investment.
The proposed AIFMD stipulates that providing professional investors domiciled in the EU pitchbooks, offering documentation and constitutional documents (such as PPM and LPA) is not marketing that requires the passport, unless those documents contain subscription documents in any form or enable professional investors to acquire the units/shares of AIF. Even if the AIF is not yet established, AIFMs under the proposed reform will be able to provide professional investors constitutional and offering documents which must be in draft form and must state clearly that they do not constitute an offer and that they are incomplete.
All AIFMs will have to do – within two weeks of the beginning of pre-marketing activities – is send an informal letter or email to the home supervisory authority. Disclosure of addressees is not required. However, the letter shall contain the member state, periods of time in which activities took place, a brief description of activities, investments strategies presented and list of AIFs (where relevant).
The proposed AIFMD reform will enable AIFMs to speak to keystone investors and negotiate the fund structure before making a notification. However, pre-marketing is often a catalyst to an application of “reverse solicitation,” which is commonly used in the PE industry, in particular with non-EU AIFMs. In the pre-marketing period, the PE firm approaches potential investors with draft documents. Investors then may approach the PE firm at their own initiative to invest. This enables PE firms to avoid marketing approval requirements.
According to the proposed AIFMD changes, AIFMs shall ensure that investors do not acquire units/shares in an AIF through pre-marketing activities and that such investors only acquire units/shares in that AIF as the result of marketing subject to appropriate notification. Any subscription by professional investors that is subject to pre-marketing activities made within 18 months of the AIFM’s beginning of the pre-marketing, related to the information received in the context of pre-marketing activities, shall be considered the result of marketing and shall trigger a notification requirement.
Hence, AIFMs will not be able to invoke reverse solicitation under AIFMD in the context of pre-marketing, and any investment will have to be made on the basis of a marketing authorization obtained for the specific AIF. Thus, AIFMD will adopt a very strict concept of reverse solicitation, requiring the AIFM’s offer to be genuinely initiated by the investor and not induced by AIFMs.
What does it mean for non-EU fund managers?
In the end, it has to be emphasized that AIFMD applies to European managers/funds offering their services throughout the EU. Nevertheless, EU member states should not put non-EU AIFMs and EU AIFMs marketing non-EU AIFs into any advantage vis-à-vis European AIFMs/AIFs. Therefore, member states may even impose (various) additional pre-vetting obligations to non-EU AIFMs/AIFs, subject to national private placement rules (NPPRs) and there will be no guarantee for EU-wide equal treatment of non-EU AIFMs/AIFs.
It won’t matter that the new EU-wide pre-marketing regime for AIFs will not impose the date on which marketing starts to a much earlier period than what is currently acceptable market practice in major European financial hubs. The new stricter understanding of the reverse solicitation concept will significantly hinder non-EU AIFMs and EU AIFMs marketing AIFs in Europe.
Therefore, the ability of non-EU AIFMs to carry out pre-marketing activities across the EU still remains uncertain and subject to member states’ discretion.
The foregoing will be important for managers or funds domiciled in the UK as well. How would PE funds passport into Europe through the UK after Brexit, in the event they do not establish EU vehicles? In addition to NPPRs, non-EU managers or funds based in a third country can enjoy equal treatment throughout the EU only if an equivalence decision is made by the European Commission. Nonetheless, this is inherently a completely political decision and there has been little progress in the last three years.
Matija Repolusk is a US and European qualified lawyer and MBA who advises on regulation and compliance in the EU. The views expressed in this article are those of the author and do not necessarily represent those of PFM.