Marketing offshore AIFs in Europe under AIFMD National Private Placement Regime (NPPR) is still very hot topic. Notwithstanding extensive discussions and ESMA opinions in the recent past around the possibility of extension of the passport to third country AIFMs and their AIFs, with ensuing phasing out of the local national rules on AIFMD NPPR, yet there is no certainty today as to whether this will happen anytime soon (please see other post on passport extension here). Also, what nobody clearly states about the extension of the passport is that, before a right to passport can be granted, a complete authorisation of the third country AIFMs with the authority of the chosen Member State of Reference in Europe will have to be carried out, making the extension of the passport a consequence to a full scope AIFM authorisation in Europe of the third country AIFM.
But fear not. There is still and always will be appetite for third country AIFs in Europe and non-EU AIFMs should consider offering interests in their funds to European investors through the AIFMD NPPR currently available.
This post will provide some actionable and practical information dedicated to US Fund Managers on how to be successful with the marketing in Europe under AIFMD NPPR.
History of NPPR
NPPRs historically consisted of a set of safe harbour rules and exemptions from the requirement to register an offer of funds or securities with a local regulator, subject to any such private placement being carried out in accordance with set criteria. It was called private because there was no involvement of authorities. As part of the criteria, the offer had to have a certain minimum size per investor, a set number of investors were to be approached and they had to be of a specific type – most usually professional or HNW. A combination of these criteria would allow qualification to exempted status, depending on the domicile.
With the advent of the AIFMD, national regulators have changed their approach and became involved in the process – to a different extent depending on the degree of protectionism adopted for each relevant market – by means of introducing a public element in the equation. Whilst the authorities of some domiciles require a mere notification of the intention to offer, some others – the more protectionist ones shall we say – require something akin to an ex-novo local authorisation process.
Offering AIFs under AIFMD NPPR requires now that at least an application form is filled and submitted with the relevant local authority as well as a fee for the notification is paid, if any. Also, it requires that certain disclosures are made both in the offering documents and the annual reports as well as ongoing reporting is made to local authorities.
AIFMD articles 36 and 42 respectively introduced NPPR preconditions. Before applying to offer AIFs under AIFMD NPPR in certain EU domiciles, third country AIFMs will have to ensure compliance with the preconditions stated under AIFMD. Whilst some national authorities have replicated tout-court and without significant amendments these AIFMD preconditions in their local laws implementing AIFMD, some others have added additional local requirements for their NPPR. The so-called gold plating.
AIFMD NPPR comes into play any time that i) a EU AIFM intends to offer interests in non-EU AIF or in EU AIF feeding into a non-EU master fund (article 36 AIFMD); as well as ii) anytime that a non-EU AIFM intends to market a non-EU AIF to investors in Europe (article 42 AIFMD).
This post concentrates on the private placement rules under AIFMD article 42, applicable to non-EU AIFMs intending to market non-EU AIFs in Europe.
Article 42 Conditions
The conditions imposed by AIFMD article 42 operate at two distinct levels. A set of conditions applies at the AIFM and AIF level and translate in the transparency requirements we will discuss in further details below.
An additional set of conditions operates at the level of the third country domicile [of the AIFM and AIF] and relates to the extent of cooperation existing between the national competent authorities of the domicile of establishment of the third country AIFM and AIF and the ones of the EU domicile where the offer is intended to take place.
There are also additional conditions, stemming from local implementation of AIFMD in the EU domiciles where a gold plating approach has been adopted by local national regulators.
NPPR Transparency Requirements
Transparency requirements are a clear example of the ultra-territorial effect of AIFMD provisions. In fact, whilst an AIFM is not a European entity, it will have to comply with the provisions of European regulation because it intends to offer to investors with a domicile or registered office in Europe.
From a practical standpoint, compliance with transparency requirements will typically require that some work is done on the offering documentation in advance of filing an AIFMD NPPR application, as well as on annual reports going forward, in both cases to cater for the additional disclosures imposed by the AIFMD. The disclosures to be contained in the offering memorandum shall be included therein before the AIFMD NPPR filing submission is made, whilst the ones required for the annual report, instead, can be added in the set of reports due immediately following the time of the authorisation to market under NPPR.
The ongoing reporting obligations will require either acquiring specific pieces of software or the outsourcing to specialist service providers. Also, the remuneration arrangements in place will have to be disclosed in the annual reports.
Let’s see these transparency requirements a little closer:
Disclosure Obligations – certain pre-sale information has to be disclosed in the fund offering documentation. Some of the requirements imposed under AIFMD on pre-sale disclosure do not substantially diverge from generally accepted standards and good market practice and consist accordingly in the description of i) investment strategy and objectives; ii) types of investable assets; iii) investment techniques and associated risks and restrictions; iv) use of leverage. This being said, article 23 of AIFMD contains additional disclosure requirements, which are not necessarily already contained in a standard offering memorandum. It is advisable that AIFMs take in consideration these disclosure requirements under article 23 and familiarise with these. We have seen a growing practice of creating an appendix to the offering memorandum to integrate such additional information, called AIFMD annex. Amongst the specific disclosures contained under article 23 AIFMD, the following are worth to mention i) legal implications of the contractual relationship entered with the AIF; ii) delegation of management function and safekeeping function; iii) valuation procedure and pricing methodology; iii) description of how fair treatment of investors in ensured and rights to preferential treatments.
Besides the pre-sale disclosures, AIFMs need also to disclose periodically to investors a) percentage of assets which are subject to special arrangements due to illiquidity; b) new arrangements for liquidity management; c) current risk profile and risk management systems employed.
Annual report – an annual report will have to be made available no later than 6 months from the end of the financial year of each AIF marketed. The annual report shall be provided to the host state authority where the AIF is privately placed as well as to investors upon demand. The annual report shall contain i) balance sheet; ii) income and expenditure account; iii) report on activities; iv) any material changes to the information disclosed in the private placement memorandum; v) disclosure on remuneration paid to the staff (i.e. total remuneration for the year, split into fixed and variable remuneration paid by the AIFM to the staff, as well as aggregate amount of remuneration broken down by senior management, members of staff who can affect the risk profile of AIF). The accounting information contained in the annual reports will have to be prepared in accordance with the standards of the third country where the AIF is established. Also, the annual report will have to be audited.
It is noteworthy to mention that whilst the requirements for the annual reports seem to be in line with the general standards imposed by wider market practice, AIFM shall pay particular attention to both the report on the material changes to the information disclosed to investors in the private placement memorandum as well as the breakdown on remuneration.
Reporting to regulators – besides providing the annual report, it is required to report to the regulators of the EU countries where the AIFs are marketed, on a frequency that depends on the AUM (semi-annually or quarterly if exceeds 1 bn AUM), on the following i) overall level of leverage employed; ii) main instrument traded and markets: iii) principal exposures; iv) most important concentrations. The report is commonly defined as Annex IV and requires a different format for the different regulatory authorities in the various jurisdictions across Europe. Many found similarities between the Annex IV report and the Form PF, which is something that should possibly ease the task for US managers.
NPPR Cooperation requirements
The Cooperation requirements are relatively straightforward. An AIFM has to ensure, before applying for marketing under national private placement regime, that these conditions are fulfilled.
Cooperation – Cooperation agreements, executed in line with the standard set by ESMA, need to be in place between the EEA state in which the AIF is marketed and, respectively, the regulatory authority of the non-EU AIFM and AIF. Such agreements are related to the sharing of information and cross-border supervision of AIFs.
Non-FATF – Both the non-EU AIFM and non-EU AIF need to be established in a country which is not listed as non-cooperative country and territory by the Financial Action Task Force on anti-money laundering and terrorist financing.
So, you complied with the conditions above and obtained private placement authorisation in the domiciles you applied for.
Now let’s look at the marketing.
A definition of marketing is contained under the AIFMD as follows: a direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM of units or shares of an AIF it manages to or with investors domiciled or with a registered office in the Union.
Delegated AIFMD level 2 regulation does not contain any further guidance on the subject of marketing, which is consequently left at local level to be governed. As at today, due to the fact that there is also no European directive on marketing, there is accordingly no uniform view across Europe and the various member state have been adopting so far different approaches on marketing. As it is conceived under AIFMD, marketing is only directed towards professional investors.
Of course, marketing can not only be carried out by AIFMs, but also by third parties on their behalf. On this point, we would most normally consider 3rd party marketers, distributors and capital introduction professionals as entities capable of performing marketing activities on behalf of the AIFM provided these are entities are contracted to act as such.
NPPR Premarketing, Soft Marketing
Most commonly, premarketing is used to gauge potential interest from investors in a strategy or investment idea and takes place when a few elements of the offer are still missing, like the AIF itself or its name, as well as the final version of the documents or the subscription agreements or documents. In the alternative investment space, the ability to share draft documentation with potential investors is of paramount importance to agree terms of the various deals in a way that is satisfactory to anchor investors. Again, different countries take a different view on this and there is no one size fit all answer on the boundaries of premarketing.
Recently the EU Commission has proposed a definition of premarketing to be adopted through an ad-hoc revision of AIFMD (read more about it here). After a heavily chastised first attempt to define premarketing, deemed unrealistic and restrictive by the industry for various reasons, the revised definition of premarketing opens to a more pragmatic solution that preserves the ability of managers to share draft documentation with potential and anchor investors in order to arrange with these the terms of the investments.
Pursuant to the current definition of premarketing, it is excluded in cases where investors are provided with documentation that a) enables them to commit to or acquire shares of an AIF; b) amounts to a final prospectus of a not-yet established AIFs, or c) amounts to a final or draft subscription agreement allowing investors to commit to an investment. In cases where a draft prospectus is provided, it should contain a disclaimer to the extent that the provision of the document should not be construed as an offer to subscribe for the shares in the AIF.
Recital 70 AIFMD states that the directive should not affect the current situation where a professional investor established in the union may invest in AIFs on its own initiative, irrespective of where the AIFM and/or AIF is established. Notwithstanding the fact that reverse enquiry was prohibited in one of the first drafts of the AIFMD, it was reinstated in the final version. The reasons for its reinstatement are linked firstly to a heavy lobbying from the hedge fund industry, then the need to ensure diversification of investment for large professional investors as well as the fear of perceived protectionism under international treaties.
As at today there is little to no guidance on reverse enquiry at European level. In reality, reverse enquiry is regulated at a local level and, similarly to marketing, receives a different treatment in different countries.
Reverse enquiry is an uncodified situation, which per se eliminates the offer because it is the investor to reach out to an offeror to invest in a security without the offeror having to make any solicitation or offer as such. Over time, reverse enquiry has been interpreted in various ways in the practice of few, more open, regulatory authorities and it has been looked at from the perspective of the relationship. Should the initial approach be made in line with the marketing requirements, then it is acceptable to keep on reaching out to that same investor with new products, without it constituting an offer. However, given also the fact that new marketing strategies, especially with the advent of internet, are arising, reverse enquiry has been interpreted lately from a transactional perspective, with every transaction requiring a spontaneous approach from the investor to the manager. This would also be in line with the concept of reverse enquiry as it is envisaged under MiFID II directive.
Since implementation of AIFMD we can identify now a few do’s and don’ts of reverse enquiry. As far as internet presence is concerned, websites should i) be password protected; ii) contain little to no reference to performance; iii) grant access product by product and also iv) not be visible in countries where the regime on reverse solicitation is rather unfavourable and not translated in local language. Newsletters should be made for individual funds only and should not mention new or additional funds other than the ones already subscribed for by the investor.
Also, it is important to check beforehand the approach of a specific country on reverse enquiry and consider that it may have implications and consequence from a legal and financial standpoint. As a matter of fact, whilst it is unlikely that the various regulatory authorities may be able to identify increased allocations made to a non-EU manager and pick up on a potential misuse of reverse enquiry, particular attention must be paid to investors in that they may sue managers in order to have agreements rescinded and full recovery of monies invested in case of misapplication of reverse enquiry.