This note examines the consequences of the current Directive text for third country fund managers and considers the probable impact (intended or otherwise) of the draft provisions on EU investors. The Directive is merely at the start of the EU’s legislative process and it is inevitable that amendments will be made to its text before the Directive comes into force. It is to be hoped that such amendments will resolve a number of areas (indicated below) where greater clarity is needed. This note seeks to provide indicative guidance only – if you require legal advice on any issue, you should seek appropriate professional assistance.
1. As a third country fund manager, can I market funds within the EU under the Directive?
An EU member state may authorise a third country fund manager to market an AIF of which it is the manager across the EU, provided a number of conditions are satisfied.
(See paragraph six below in respect of the conditions referred to; see paragraph 10 below for the meaning of the term “marketing” under the Directive.)
2. Do I need to establish a place of business in the member state in which I am seeking authorisation?
Based on the current draft of the Directive, it would seem not. However, in practical terms, it may prove hard for a third country fund manager to satisfy all the conditions which the Directive imposes (see paragraphs six and seven below for further details).
Fund managers which are established and authorised in a member state and which wish to market a non-EU AIF within the EU need comply only with a single condition – see paragraph 11 below. As a result, it may be that third country fund managers which wish to continue to market their AIFs in the EU will be forced to establish a place of business in the EU and to become authorised under the Directive.
3. Does it make a difference where the fund is domiciled?
From the current draft text of the Directive (though subject to clarification), it appears that third country fund managers that wish to market to EU investors would require authorisation from a member state to market not only non-EU AIFs (such as Cayman funds) but also AIFs which are domiciled within the EU (such as in Ireland or Luxembourg). If this is, indeed, correct, it will not be enough for a third country fund manager to establish an EU AIF for marketing to EU investors in order to avoid the need to obtain marketing authorisation.
4. Do I need authorisation from each member state I want to market in?
It appears that authorisation would be required from one member state only, and not from each member state in which the AIF is to be marketed, though, again, this remains to be clarified.
5. To which EU investors can I market funds?
To ‘professional investors’ within the meaning of Annex II of the Markets in Financial Instruments Directive.
6. What are the conditions referred to in paragraph one above?
There are five conditions, namely:
Condition (a)
The EC must have taken a decision that the jurisdiction in which the third country fund manager is established (the third country) has legislation regarding prudential regulation and ongoing supervision which is “equivalent” to the Directive’s provisions and that this legislation is effectively enforced.
Condition (b)
The EC must have determined that the third country grants effective market access to EU fund managers, which is comparable to that granted by the EU to fund managers from the third country.
Note that the Directive provides for a two stage process in relation to these two conditions.
First, the EC must adopt implementing measures aimed at establishing:
• in relation to condition (a), general equivalence criteria for the equivalence and effective enforcement of the third country’s legislation on prudential regulation and ongoing supervision; and
• in relation to condition (b), general criteria for assessing whether the third country grants EU fund managers effective market access comparable to that granted by the EU to fund managers from the third country.
The EC must base its ‘general equivalence’ criteria on certain requirements which are laid down in the Directive in relation to EU fund managers. These include the obligation to:
• maintain a minimum initial and ongoing level of regulatory capital;
• ensure that any AIF of which it is the AIFM appoints an independent custodian and an independent valuation agent;
• comply with various conduct of business rules, restrictions on delegation and transparency obligations with respect both to disclosure to investors and reporting to regulators; and
• comply with leverage limits which are to be determined by the EC.
Second, on the basis of these general criteria, the EC must adopt implementing measures which state that:
• the third country’s legislation on prudential regulation and ongoing supervision of fund managers withinits jurisdiction is equivalent to that under the Directive and is effectively enforced; and
• the third country grants EU fund managers effective market access at least comparable to that granted by the EU to fund managers in the third country.
Condition (c)
The relevant regulatory authorities of the member state in which the third country fund manager is seeking authorisation must have entered into a cooperation agreement with the “supervisor” of the third country fund manager which ensures an efficient exchange of all information that is relevant for monitoring the potential implications of the activities of the third country fund manager for the stability of systemically relevant financial institutions and the orderly functioning of markets in which the third country fund manager is active.
Condition (d)
The third country must have signed an agreement with the member state in which the third country fund manager is applying for authorisation to share information on tax matters which fully complies with the standards laid down in the OECD Model Tax Convention and which ensures an effective exchange of information in tax matters.
Condition (e)
The third country fund manager must provide the regulatory authorities in the member state in which it is applying for authorisation with certain information, including information on the identities of its shareholders or members that have a direct or indirect holding in it which represents 10% or more of its capital or voting rights.
7. Will I be able to satisfy these conditions?
This will depend on a number of factors, not least the country in which you are established.
However, it seems very unlikely that all of the five conditions referred to above could be satisfied and, as a result, third country fund managers may be prevented from marketing their AIF in the EU under the Directive, unless they establish a place of business in a member state and seek authorisation as an AIFM under the Directive.
8. When do these rules apply?
It is the intention of the EC to finalise the contents of the Directive swiftly, preferably by the end of 2009. Whether or not this is a realistic timetable remains to be seen. In any event, it is unlikely that the Directive would come into force within the EU before the latter half of 2011.
However, a member state will only be able to authorise a third country fund manager to market AIFs to professional investors in the EU with effect from three years after the date on which the Directive comes into force in that member state.
9. What happens in the meantime?
While EU fund managers will be permitted to market non-EU funds in the EU during this three year period under the existing national private placement rules currently in force in the various member states, it is not clear whether third country fund managers will also be permitted to do so and this will need to be clarified.
10. What is the meaning of “marketing” under the Directive?
Article 3(e) of the Directive defines marketing as meaning:
“any general offering or placement of units or shares in an AIF to or with investors domiciled in the [EU] regardless of at whose initiative the offer or placement takes place”.
This definition, therefore, extends to responding to unsolicited approaches. So, if a third country fund manager receives an unsolicited approach from an EU investor, such as an EU fund of hedge funds, any response to that approach is likely to constitute marketing.
Where a third country fund manager is approached by a non-EU entity acting on behalf of an EU investor (or which is a non-EU affiliate of an EU investor), it should be possible for the third country fund manager to avoid being treated as marketing to the EU investor so long as it deals only with the non-EU entity (though this is subject to any contrary indication in the legislation of the relevant member state implementing the Directive). In addition, the provision of periodic reports by a third country fund manager to existing EU investors in an AIF of which it is the manager should not constitute marketing to such investors, provided that such reports do not contain any offer to subscribe for additional shares or interests in the AIF.
Where an existing EU investor makes its own determination to subscribe for additional shares or interests, the position is less clear and this will need to be clarified.
11. What are the main issues for third country fund managers?
The likely inability of a third country fund manager to satisfy the conditions set out at paragraph six above could result in EU pension funds and similar institutional investors being substantially restricted in the choice of AIFs in which they may invest.
Moreover, if the EU effectively locks out AIFs managed by third country fund managers in this way, third countries may reciprocate and lock out AIFs managed by EU managers from the markets of those third countries.
It should also be noted (as mentioned at paragraph two above) that EU fund managers which wish to market a non-EU AIF within the EU need comply only with a single condition similar in effect, though not identical, to condition (d) above.
Thus, where an EU fund manager wishes to market a Cayman (i.e., non-EU) AIF under the Directive to professional investors in, for example, France, Sweden and the Netherlands, the only condition which would need to be satisfied would be for each of the three member states to have entered into an agreement to share information on tax matters with Cayman (the country of domicile of the non-EU AIF).
Using the same example, but replacing the EU fund manager with one from the US (i.e., a third country), condition (d) above requires the member state in which the manager is seeking authorisation to have entered into a tax information sharing agreement with the US (being the country of domicile of the third country fund manager) and not Cayman, since the condition is irrespective of the domicile of the AIF.
The stated purpose behind the tax agreement provision is to ensure that EU national tax authorities are able to obtain such information from the tax authorities in the country in which the non-EU AIF is domiciled as is necessary to enable them to tax their domestic investors in that AIF.
However, in the latter example, it is hard to see how this intention is to be realised by obtaining an agreement with the US rather than with Cayman.
Given the restrictions on the marketing within the EU of non-EU AIFs, AIMA estimates that the Directive, if implemented without amendment, would have the effect of denying EU investors access to a significant proportion of the AIFs which may now be marketed to them.
12. Delegation
As mentioned at paragraph six above, when establishing general criteria for the equivalence of third country legislation in relation to prudential regulation and ongoing supervision, the EC must have regard to the obligation of EU fund managers to comply with certain restrictions on the delegation of their functions.
These include a restriction that portfolio management and risk management may only be delegated to a third party which is, itself, authorised as an AIFM to manage an AIF of the same type and that the third party may not delegate any of the functions delegated to it.
It remains to be seen how the EC will interpret these requirements in relation to third country fund managers’ delegation of portfolio and/or risk management functions to their affiliates (whether or not from the same third country) and to any delegation of such functions by those affiliates.
13. Placement agents
Although the Directive is unclear on the point, it appears that the EC’s intention is that third country based third party distributors, placement agents and the like will only be permitted to market an AIF to professional investors in the EU if the third country fund manager of such an AIF is permitted to do so on the basis described above.