AIFMD compliance for family office investment vehicles. This Blog-post Reproduces an Article already Published on AlphaWeek.
Family offices have been ramping up since the 2000. Whilst the most traditional structure is the single-family, nowadays we see increasingly many more entities, with a more sophisticated approach and “hedge-fund type” style of investment, in charge of managing the wealth of multi families.
Family offices enjoy a very different regulatory treatment in Europe and in the US. However, considerations are somewhat convergent and results identical for what concerns application of some European regulation, AIFMD in particular. Both European and US based family offices are not immune from AIFMD under certain circumstances and need to design carefully the structure of investments and co-investments deployed in Europe in order to manage overall exposure to AIFMD.
Regulatory considerations on structures – US vs EU
The regulatory pillar of the internal structure of family offices is the provision of investment advice. This is a common feature across the world. This being said, the regulatory treatment and categorisations of family offices in the United States is different than the one in Europe.
In the United States, the Dodd Frank Act played a pivotal role in this space and contributed to define a clear-cut structured approach towards these entities. Pre Dodd-Frank, the usual route for family offices was to apply for an exemption under the Investment Advisor Act. With the advent of the new legislative framework, instead, a definition of family office was introduced directly under the Investment Advisor Act with the qualifying conditions remaining by and large the same used previously for the exemption. The introduction of a definition also brought some more order in respect of the features of family offices, with some secondary regulation issued by the SEC to better identify the most typical features of family offices, from ownership structures and board composition, through non-investment advisory services provided.
Diametrically opposed treatment is received by family offices in Europe, which do not enjoy an ad-hoc regulatory definition and are categorised simply on the basis of the regulated services provided. To a certain extent, realistically, certain family office in Europe are able to stay out of the regulatory radar altogether. The premise is very simple and revolves around the management of the wealth of a single family only. In this scenario, entities are not seen as a threat for the economy or the system and they are not required to undertake a path of regulation.
Family offices involved in the management of the wealth of more families, be it for reasons related to economies of scales or family interconnections, lend themselves to a more complicated regulatory treatment than the single-family model, with more regulation to abide to and licenses to obtain for the regulated services offered to the multi families.
The role of external capital for AIFMD compliance purposes
So, if family offices are by and large private investment advisors and are regulated as such, what is the concern for AIFMD compliance? When is that AIFMD comes into play for family offices, if at all? Typically in the investment phase, when vehicles are created and investments are deployed in pool with other investors.
The AIFMD contains in fact an exclusion from its scope for investment undertakings that are utilized to invest the private wealth of investors, without raising external capital. In other words, investment vehicles used for the capital of a single family are not considered to be Alternative Investment Funds (AIF). Whilst this does not equate to saying that family offices investment structures per se are not at risk at all of falling under AIFMD in the course of their investments, it is an interesting starting point for the analysis. As highlighted in the Perimeter Guidance Manual of the UK FCA, for instance, the assessment of whether an investment vehicle used by a family office is caught under AIFMD or not is based on the concept of capital. Namely, on the differentiation between internal and external capital in the investment structure. Given that an AIF per definition is used to raise capital that is external to the organisation in charge of managing that AIF, we can conclude that in all instances where an element of external capital can be found in an investment structure, those vehicles are caught by the provisions of AIFMD.
So multi-family office investment vehicles, for this matter, are very likely to be caught by AIFMD. Also, in the increasing instances where a single-family office would act in an investment alongside other entities, those vehicles shall most likely be treated as AIFs.
But that’s not all. AIFMD compliance is not exclusively a concern for European family offices. In fact, as we know, there are ultra-territorial effects within AIFMD that extend also to non-EU entities in all the cases where European investors are concerned. So, in a scenario where a non-European family office would co-invest with other European investors, for instance, the specific vehicle would be considered falling under AIFMD and the principle of private placement under AIFMD, in addition to any gold-plating provision in force in the specific domicile, be applicable to that investment or transaction.
Wolf in sheepskin?
The US type of family office is a different animal than the EU version altogether. It is worth to mention that from 2015 onward we witnessed a trend of hedge funds transitioning to the family office model. Due to a combination of poor performance, requirements for increased transparency, disclosure and costs for regulatory compliance, former hedge fund managers – some of them very famous – decided to get dismiss outside investors and manage under a much lighter regulatory regime investments of their families and employees. Favoured by the regulatory regime in place in the US, this trend contributed to the evolution of a concept of family office in the US that is very close to a hedge fund, rather than an institution that takes care of preserving the wealth of a single family and to provide life events related services. We see that this is increasingly becoming the case also in Europe.
We believe that, especially when managing significant amount of assets, those entities have to receive the attention of regulators and their activities be falling under existing regulation for that they can realistically contribute to the systemic risks that specific regulation is trying to prevent.