In a recent survey of London hedge fund Chief Operating Officers, the number one concern cited about the Alternative Investment Fund Managers Directive (AIFMD) was its potential impact on their firms’ ability to market non-EU alternative investment funds (AIF) to European professional investors. Perhaps surprisingly, given many in the industry comment that Europe, when compared to say the US, Switzerland and Asia, is a comparatively minor source of capital for hedge funds, 76% of respondents said they currently market to European investors through private placement. Of those currently marketing to EU investors, 9% said they plan to cease and 35% said they were unsure whether they would continue to do. So what is their concern? The main drivers appear to be the very broad definition of marketing in AIFMD, and a concern that AIFMD will shift marketing practices up the radar of European regulators, some of whom may take a more robust approach to the policing of marketing than in the past.
AIFMD broadly defines marketing as a direct or indirect offering or placement of an AIF at the initiative, or on behalf of, the alternative investment fund manager (AIFM), to investors domiciled, or with a registered office, in the EU.
Until at least July 2015, only EU AIFM of EU AIF will be able to market to EU professional investors, subject to home regulatory approval, via a European passport. EU AIFM of non-EU AIF, or non-EU AIFM, will only be able to market through private placement, the country-by-country rules which govern the marketing of AIFs to EU professional investors. Despite now being less than four months away from AIFMD’s July implementation date, there is still considerable uncertainty in many countries about what these private placement rules will be. The UK, Ireland and The Netherlands have confirmed their rules will remain largely unchanged, whilst Germany has effectively closed the door to marketing. Other countries such as France, Spain and Italy have yet to clarify their position, although historically, it has not been possible to actively market into these countries.
The alternative to marketing via private placement is to rely on ‘reverse solicitation’ or ‘passive marketing’, which is generally understood to mean the initial contact with the manager is only at the initiative of the investor. The reality is reverse solicitation is how many managers have dealt with the restrictions and complications of regulations to date, by relying on ‘word of mouth’, introductions by their prime brokers’ capital introduction teams or referrals by other investors.
Firms marketing through private placement will be required to comply with a number of provisions of the AIFMD including certain disclosure and reporting requirements and the so-called ‘depositary-lite’ regime. AIFMs choosing to rely on reverse solicitation will avoid a number of these requirements. Over 75% of respondents to the survey said they expected to take a minimum of six months to become AIFMD-ready. Some of those managers now questioning whether to market to EU investors are no doubt taking the view it could be easier to rely on reverse solicitation, at least for a while, to reduce their implementation burden. Furthermore, non-EU AIFM that rely solely on reverse solicitation can remain outside of the scope of AIFMD in its entirety until at least July 2015. This may be attractive, given the alternative for many large non-EU managers is regulatory reporting to multiple EU regulators from September 2013 onwards!
Historically, the distinction between active and passive marketing has been a grey area and there has been little regulatory guidance. The AIFMD does not provide any specific details on passive marketing and there is no ESMA guidance. The recent FSA second AIFMD consultation paper goes further but re-iterates that only communications which are solicited at the initiative of the investor should be considered as passive marketing, whilst an organised marketing campaign or information made publicly available on a website would not.
The Alternative Investment Management Association (AIMA), in their response to the HM Treasury AIFMD consultation paper, commented that an EU AIFM managing a non-EU AIF should be able to provide general information about the AIFM to prospective investors, without referring to the track record of the AIFM, and that this should not amount to marketing an AIF. AIMA considers that if a prospective investor, following receipt of such general information about the AIFM, requests offering documents in relation to an AIF, the request of the prospective investor should be considered a reverse solicitation and not marketing at the initiative of the AIFM. Having said this, the track record is the first thing many investors will look for in any material they receive!
Other specific questions are being asked, for example:
For those managers utilising a third party marketer, the marketer will more than likely be performing indirect marketing under AIFMD. It will become more important than ever to have a clear understanding of how, and to whom, the third party undertakes marketing, particularly for non-EU AIFMs who will be required to report to regulators in each EU jurisdiction in which they market. On the other hand, it seems reasonable that the introduction of investors by investment consultants should, in the absence of an arrangement with the AIFM, not be treated as marketing. However, depending on the information made available to the end investor (for example information about the AIFM on a consultant’s database), this could also constitute indirect marketing under the AIFMD.
Whilst uncertainty and ambiguity will no doubt remain, there is an expectation it could become harder to rely solely on reverse solicitation. Several hedge fund COOs have commented that it is hard to comply with reverse solicitation all the time. Firms will need to review their procedures, including the data captured via websites and CRM systems, and implement enhanced compliance monitoring and oversight to ensure that they do not undertake ‘marketing’ as defined by AIFMD.
There is also an expectation that there will be more regulatory focus on marketing practices across Europe post-AIFMD. What might have been accepted practice in the past may no longer be the case. The stakes could be high, given a claim could be brought against the AIFM for mis-selling or local EU regulators could report an AIFM to their home regulator. Anecdotally, this appears to be the reason a number of US hedge fund managers (non-EU AIFM) are concerned about placing reliance on passive marketing – many of them are sensitive to anything which could put them on the radar of the SEC.
Given the potential difficulties marketing to EU investors through private placement, it is surprising very few firms appear to be considering re-domiciliation of their existing offshore funds to Europe in order to access the European passport. In the survey, only 5% of respondents said they were considering this, whilst 80% said they were not and the remainder were unsure. It is possible some of these firms are adopting a ‘wait and see’ approach, but is this a fundamental strategic question firms should be asking of themselves? There are challenges associated with re-domiciliation of a fund from one jurisdiction to another, and the funds would then need to comply in full with AIFMD, including the requirement to appoint a single depositary with the increased cost that may result. However, there could be significant advantage to be gained from being a regulated EU AIFM of an EU AIF without the restrictions imposed on their UCITS cousins. It could open up a whole new market for hedge funds across Europe including countries such as Germany, France, Italy and Spain which have largely been ‘off limits’ from an active marketing standpoint to date. Many European investors are wary of hedge funds and in particular those domiciled offshore. Whilst it won’t be immediate, and some think it won’t be the case at all, an AIFMD badge, rather like the UCITS badge, could have its advantages. Despite the challenge of re-domiciliation, there could be a significant first mover advantage given the relatively low number of EU domiciled hedge funds.
In some respects, the changes ahead and how managers will respond are just another example of the ‘institutionalisation’ of the hedge fund industry. Managers need to pay close attention to marketing as they progress their AIFMD implementation. Those who want to market through private placement will need to monitor the private placement rules in the countries they are targeting, and for those seeking to rely on reverse solicitation, robust controls will be required. It is clear that marketing in the post-AIFMD era is going to receive a lot more attention over the coming months.
Bill Prew is the founder of INDOS Financial Limited, an AIFMD related business which will formally launch later in 2013.