The EU Cross-Border Distribution Framework1 introduces a new framework for the cross-border distribution across the EU of UCITS and alternative investment funds ("AIFs"). The majority of the most significant changes are expected to apply under local member state law from 2 August 2021. The purpose of this briefing is to highlight the preparations that fund managers should be undertaking in the months running up to the new framework coming into effect.
New Pre-Marketing Regime
Scope: The framework introduces a new concept of "pre-marketing" and the conditions for its use by EU authorised AIFMs. Importantly the pre-marketing regime does not apply to UCITS, registered/sub-threshold AIFMs or non-EU AIFMs. It remains to be seen whether individual EU member states will amend their national regimes to bring them in line with the provisions applicable to EU AIFMs.
Definition of pre-marketing: The key features of "pre-marketing" comprise the following:
- it involves the provision of information or communication, direct or indirect, on investment strategies or investment ideas;
- by an EU AIFM or on its behalf (e.g. a distributor or placement agent) Significantly, the types of delegates of the AIFM that can avail of the pre-marketing regime on behalf of the AIFM is limited to EU regulated entities (MiFID firms and tied agents, banks, UCITS management companies, and other AIFMs) and so this will limit the ability of EU AIFMs to use non-EU distributors/placement agents at the pre-marketing stage;
- to professional investors in the EU;
- in order to test their interest in an AIF, which is not yet established or is established but not yet notified for marketing under AIFMD in the relevant member state;
- which does not amount to an offer to invest in the relevant AIF.
Pre-marketing will not be permitted where the information provided:
- enables investors to commit to acquiring an interest in the AIF;
- comprises subscription documents (in either draft or final form);
- comprises constitutional documents or offering documents of a not-yet-established AIF (in final form).
Pre-marketing disclaimers: Draft offering documents will need to include a disclaimer that they do not constitute an offer or invitation to subscribe for an interest in the AIF and that the information presented should not be relied upon because it is incomplete and may be subject to change.
Notification to home member state regulator: The EU AIFM's home member state regulator must be notified within two weeks of the pre-marketing activity commencing. This notification must be provided by way of an "informal letter" and:
- specify the member states in which, and the periods during which, the pre-marketing is taking or has taken place;
- include a brief description of the pre-marketing including information on the investment strategies presented; and
- include, where relevant, a list of the AIFs subject to the pre-marketing.
Subsequent marketing/acquisition of interests in AIFs: Any subsequent acquisition of interests in a fund by investors contacted by way of pre-marketing can only be carried out after the relevant AIF has obtained the requisite marketing permission/passport in the relevant EU member state.
Limitation on reverse solicitation: The pre-marketing regime should introduce a level of consistency across the EU in respect of acceptable activities prior to formal "marketing" commencing. However, it will have a very real effect on the ability of EU AIFMs to rely on reverse solicitation. The framework provides that any subscription by a professional investor in an AIF, which occurs within 18 months after the pre-marketing activities for that AIF, shall be considered to be the result of marketing and shall be subject to the AIFMD marketing notification/passporting procedure. The consequence of this is that an EU AIFM will not be able to rely on reverse solicitation for a period of 18 months after conducting pre-marketing activities. It is not clear whether the provision which deems a subscription within 18 months after pre-marketing activities to be the result of marketing activities is to be read as referring to pre-marketing activities in the member state of the relevant investor, although this would appear to be the sensible interpretation of this provision. Accordingly, managers will need to take a cautious approach on this point and will need to ensure that their process around reverse solicitation is sufficiently robust and adequately documented in light of the new framework.
The framework2 also introduces harmonised standards for marketing communications for UCITS and AIFs.
Such communications must:
- be identifiable as marketing communications;
- describe the risk and rewards of investing in an equally prominent manner;
- be "fair, clear and not misleading";
- in the case of UCITS management companies, must indicate that a prospectus exists and that the key investor information document is also available. Such communication shall specify where, how and in which language investors can obtain the prospectus and the KIID and provide hyperlinks or a website for those documents;
- specify where, how and in which language investors can obtain a summary of investor rights and provide a hyperlink to such a summary, which shall include, as appropriate, information on access to collective redress mechanisms at EU and national level in the event of litigation; and
- also contain clear information that the AIFM or UCITS management company may decide to terminate the arrangements made for the marketing of funds in accordance with the UCITS Directive/ AIFMD.
The framework permits regulators to require prior notification to them of marketing communications for UCITS, and AIFs that are marketed to retail investors, but this requirement will not be a pre-condition to them obtaining marketing permissions/passports under the UCITS Directive/AIFMD. If the regulators require any amendments to the marketing communications they must inform the fund management company of any such requests within 10 business days of its submission.
ESMA Guidelines: Under the framework, ESMA was required to develop guidelines on the application of these requirements for marketing communications, including on-line communications. ESMA consulted on proposed draft guidelines in November 2020 and on 27 May 2021 issued its final guidelines ("Guidelines"), which includes a feedback statement from the consultation. In the feedback statement, ESMA highlights the revisions to the draft Guidelines that it has made on foot of the responses it received to the consultation. These include clarifications on the responsibility of fund managers with regard to third-party distributors, amendments to what are termed the "positive" and "negative" marketing list examples, and on-line marketing requirements.
Significantly the draft Guidelines had included communications that describe the characteristics of a fund which are provided to distributors and ultimately are addressed to investors/potential investors as a marketing communication, even if they were not intended to be provided to investors or potential investors. In response to the feedback received from the consultation, ESMA has removed this example from the "positive" list of marketing communications. ESMA also clarified that information communicated in the context of pre-marketing should not be considered a marketing communication.
The draft Guidelines had also placed a responsibility on fund managers for ensuring that marketing communications issued by third-party distributors were in compliance with the Guidelines. In response to the feedback it received, ESMA has removed this requirement, noting that the framework specifies the requirements for marketing communications, but does not explicitly address fund managers' responsibility for their content, and so this initial requirement went beyond the scope of the Guidelines.
The Guidelines provide detailed guidance on the following:
- the suitability of the marketing communication to potential/target investors;
- consistency with other documents (the prospectus, KIID, constitutional documents, periodic reports and information disclosed on websites under the EU Sustainable Finance Disclosures Regulation (SFDR));
- the description of the features of the investment information on costs;
- information on past performance and expected future performance; and
- information on sustainability-related aspects.
The Guidelines set out prescribed formatting and content requirements. For example:
- the Guidelines prescribe particular forms of disclaimers in both traditional marketing materials and social media posts on the identification of marketing communications;
- in relation to the equally prominent disclosure of risks and rewards, there is Guidance in relation to the font size used and positioning of risk disclosures. The Guidance states that having a two-column table differentiating risks and rewards is a good example of how they can be presented in an equally prominent manner;
- managers will also need to be careful about how they present risks and rewards for funds that are recently set up and for which no past-performance records are available. In this case, the reward profile may be represented only by reference to the benchmark's performance or to the objective return, when a benchmark or objective return are envisaged in the fund documents. Disclosing a simulated past performance is also restricted. It should be limited to marketing communications relating to any share class of an existing fund or investment compartment where the performance can be simulated on the basis of the performance of another share class provided the two share classes have the same or substantially the same features and a new feeder fund whose performance can be simulated by taking the performance of its master;
- the Guidelines also provide that the marketing communication should be written in the official languages of the member state where the fund is distributed, or in another language accepted by the competent authority of that member state; and
- the Guidelines include detail on disclosure in marketing communications on sustainability-related aspects of the investment. In particular, the information should be consistent with the information included in the legal and regulatory documents of the promoted fund, and a link to the website where information on sustainability-related aspects is provided pursuant to the SFDR should be included in the marketing communication, where relevant given the nature of the marketing communication.
It will be important for both UCITS and AIFMs to take account not just of the high level principles in the framework but also the more detailed Guidelines when considering the issuance of any marketing communications in connection with funds being offered in the EU. Managers will need to ensure that they carry out a gap analysis of any marketing communications, irrespective of format or the medium through which they are delivered, to ensure that they meet all the requirements of the Guidelines and, in particular, that they include the disclaimer and other prescribed language in the Guidelines.
The Guidelines will apply six months following their publication on the ESMA website in all the official EU language translations. The publication of the translations triggers a two month notification period within which national competent authorities must notify ESMA whether they will comply, or explain why they will not comply, with the Guidelines. Therefore, although the framework will be effective from 2 August 2021, the Guidelines will not be effective until after that date. Nevertheless, fund managers should review and assess their marketing communications to prepare for compliance with the Guidelines.
The framework imposes less onerous requirements in respect of the maintenance of local facilities in host member states. This is intended to reduce differing practices and requirements in EU member states in respect of facilities agents, paying agents and similar service providers. These rules will apply to all UCITS management companies marketing UCITS and all AIFMs (EU or non-EU) marketing AIFs (EU or non-EU) to retail investors. The framework requires that they must establish local facilities in each of the host member states to perform certain tasks, including:
- processing investor subscription and redemption orders, and making other payments to investors;
- providing investors with information on how an order can be made and how redemption proceeds are paid;
- facilitating the handling of information relating to the exercise of investor rights;
- making investor disclosure documents, periodic reports, KIIDs etc. available for inspection; and
- acting as a contact point for communicating with the host member state regulator.
There is no requirement that UCITS management companies or AIFMs have a physical presence in the host member state and so such facilities may now be provided through the use of electronic means. Facilities may be provided by the UCITS management company or AIFM itself and/or by certain third parties that are subject to regulation in respect of the tasks which they perform. Assuming that member states faithfully implement the framework, it should allow management companies additional flexibility in terms of how they provide such local facilities without having a physical presence in the host member state. Firms that currently have such agent relationships, or are considering entering into them in advance of the framework coming into effect, should consult with advisors in the relevant market and re-assess their existing agent relationships.
De-Registration of UCITS and AIFs
The framework also harmonises the process for the de-registration of both UCITS and AIFs where it is no longer intended to market such funds in a particular host member state, as follows:
- except in the case of close-ended AIFs and ELTIFs, a blanket offer must be made to redeem free of any charges or deductions, all fund interests held by investors in that member state;
- the intention to terminate arrangements for marketing of the fund in the member state must be made public by means of a publicly available medium, including by electronic means, which is customary for marketing AIFs/UCITS and suitable for a typical AIF/UCITS investor;
- for a period of three years, the AIFM shall not engage in pre-marketing of that AIF, or in respect of similar investment strategies or investment ideas, in the relevant member state. This is a significant pre-condition to availing of the additional flexibility under the pre-marketing regime. Accordingly, prior to de-registering an AIF, EU AIFMs should consider carefully whether any successor strategies/funds are due to be pre-marketed in the short to medium term as this may be one reason why they would not de-register to avoid any doubt as to their ability to avail of the pre-marketing regime. Unless there is further regulatory guidance providing clarity on this, the cost-benefit analysis for managers may entail maintaining the registration of funds in particular jurisdictions after they have had their final close and bearing the continued burden of any associated regulatory fees, so as not to create any doubt as to their ability to avail of the pre-marketing regime. This will likely also mean that managers will need to look at the provisions of their subscriptions agreements/fund documents to include relevant representations and warranties from investors that they were not the target of pre-marketing in their jurisdiction, where relevant; and
- investors who remain invested in the UCITS/AIF as well as the regulators of the home member state would continue to be provided with the investor disclosures and periodic reports as required under AIFMD/the UCITS Directive.
In a welcome move for firms to have a single access point on information on the marketing regimes in individual jurisdictions, the framework also provides for the creation of central databases by ESMA for the publication of:
- national marketing requirements;
- regulator fees and charges relating to cross-border registrations;
- details of all AIFs/UCITS that are marketing on a passported basis, their AIFM/UCITS management company and the member states in which they are marketed.
Cross-Border Notification Letters
Certain other conforming changes of a more technical nature have been made in respect of the notification procedures for obtaining marketing passports under the UCITS and AIFMD regimes. In particular the information and address necessary for the invoicing of fees/charges, and details of local facilities must be included in the cross-border notification letter. In addition, in the case of UCITS, changes in the original passport notification letter, or changes in share classes to be marketing, must be notified to the regulator in the home member state and the host member state at least one month in advance of such changes taking effect.
While the new framework should introduce greater consistency and certainty in respect of a variety of aspects of marketing activities across the EU (e.g., pre-marketing, use of local facilities agents and de-registration of funds), it is clear that the additional benefits introduced by the framework are subject to a variety of technical requirements, some of which are subject to interpretation and would benefit from additional regulatory guidance. Managers are advised to consider carefully the new regime in advance of it coming into effect and ensure that their marketing/sales teams and any relevant distribution/placement agents are fully aware of the implications of the framework.
1. The framework comprises Regulation (EU) 2019/1156 and Directive 2019/1160/EU.
2. Under Regulation (EU) 2019/1156.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.