AIFMD Reverse solicitation: The basic principles

Tuesday, June 5, 2018 | By Giles Smart

AIFMD Reverse solicitation: The basic principles

The Alternative Investment Fund Managers Directive (AIFMD) applies to nearly all fund managers domiciled in the EU or who market to EU investors. However, this directive does contain some niche exceptions. Lawyers have contested that a third country manager can be excused from AIFMD compliance if they are able to demonstrate that they did not market to EU investors and that communications were initiated by the prospect prior to making a capital allocation.

Crudely translated, reverse solicitation is the outright opposite of marketing. Third country managers cannot do anything other than wait for EU investors to approach them at their own volition and without inducement. The practice has been the mainstay for a large number of non-EU fund houses in North America and APAC who wanted to avoid the costs and added requirements of complying with AIFMD, but at the same time, didn’t want to shut out EU business entirely.  

The concept of reverse solicitation is steeped in all sorts of legal risk, and there are extensive concerns about some careless third country managers juxtaposing reverse enquiry with soft marketing. European law firms have repeatedly warned these asset managers that regulators will take action against them if abuses of the rules are pervasive, and they are found to be marketing to EU investors under the radar. However, reverse solicitation is anything but straightforward.

A patchwork implementation model

The framework of AIFMD never clearly defined what constitutes as marketing in its rules. As a result, there is a very contentious and narrow line separating where reverse solicitation ends and marketing begins. The ambiguity in AIFMD’s text means that different EU national regulators have come up with their own interpretations about marketing; certain member states believe pre-marketing falls under reverse solicitation while others do not. [1]

The UK’s FCA has said sharing draft fund terms with cornerstone investors prior to fund launches falls under pre-marketing so managers do not need to notify regulators about their activities.[2] Meanwhile, France’s Autorité des Marchés Financiers (AMF) lets managers contact up to 50 professional investors prior to launch, but they are not allowed to disseminate any documentation containing information about the fund. [3]

Some markets reject the notion of pre-marketing altogether. Just as asset managers grappled with different regulatory approaches to Annex IV reporting, many have found EU member states to be equally un-aligned on the issue of marketing. As a consequence, managers distributing their products into multiple EU member states find compliance difficult, and have repeatedly urged regulators to provide greater clarity.

The EU listens

The European Commission (EC) recognized that regulatory arbitrage across member states impeded cross-border distribution of EU fund products, and have confirmed they want to remove any stifling national barriers. Harmonization, the EC said, would be facilitated as part of its Capital Markets Union (CMU) prerogative,[4] and adding marketing rules would be subject to greater cross-border standardization.

The EC has since come up with a proper definition of pre-marketing - as it applies to EU managers - referring to it as: “direct provision of information on investment strategies or investment ideas by an AIFM or on its behalf to professional investors domiciled or registered in the Union in order to test their interest in an AIF which is not yet established.” [5]

The rules specify EU firms that are pre-marketing to EU investors do not need to notify regulators and will be excused from the AIFMD during that period. Pre-marketing cannot be leveraged by relating to an established alternative investment fund (AIF) or contain any reference to one; it cannot enable investors to buy units or shares in an AIF, or even distribute prospectuses, constitutional documents or subscription forms of a not-yet-launched AIF even in draft form.[6]

At present, the proposals only impact EU fund managers, but national regulators are within their rights under Article 42 NPPR to impose it on non-EU AIFMs marketing or pre-marketing an AIF. [7] Unfortunately, there are serious drawbacks to these pre-marketing proposals, which have been flagged by a handful of industry groups including EFAMA, ICI Global, ALFI and BVI, a German-based asset management association.

The Catch

Rather than easing the ability for third country managers to raise EU capital, the rules could potentially complicate it.[8] Firstly, the proposals are more restrictive than existing pre-marketing practices tolerated by some EU member states, such as the UK. The current, cumbersome, description of pre-marketing is likely to prevent any marketing from taking place once a fund has formed.

Non-EU managers, including UK firms post-Brexit, are unlikely to receive automatic third country passporting rights in the near future as their pre-marketing options have been narrowed, and with it some of the flexibility they once enjoyed under reverse solicitation. As such, fund managers need to consider their next steps. 

Managers plan for reverse enquiry changes

Reverse solicitation constraints could lead to third country managers refusing to accept EU institutional money altogether and instead focus only on markets where capital raising is less constraining. A number of non-EU managers have argued capital raising on the continent is challenging already, mainly because investors have domestic bias and dislike certain asset classes, such as offshore hedge funds.

If European assets account for limited overall AUM, then non-EU managers have good reason to avoid EU investors and with it AIFMD compliance. For example, many US firms have acknowledged they simply do not want to add AIFMD to their expanding list of regulatory commitments, whether it be the Form PF under Dodd-Frank or the CFTC’s (Commodity Futures Trading Commission) CPO-PQR.

However, some third country managers will want to retain EU clients to maintain steady asset flows and diversification benefits. These firms will not be put off by AIFMD’s requirements (i.e. reporting to clients and regulators; appointment of a depositary and third party valuer; regimented leverage and remuneration restrictions; regulatory capital obligations), and may choose to privately place their funds or move operations onshore.

A third option does exist. The authors of AIFMD never intended for reverse solicitation to be used as an underhand marketing strategy, but as a mechanism for EU institutions to legitimately and freely access third country asset managers without subjecting the latter to AIFMD compliance. If managers want to run EU money without being constricted by AIFMD, then they should not deviate from the CMU’s pre-marketing rules.

APAC, Asset Management, EMEA, Regulation

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