A guide to the European regulatory landscape
In recent years, US fund managers have increasingly been drawn to Europe by the abundant capital that's available in the region – and by the appetite of Europeans to invest that capital with them.
Europe is the second largest private capital market and boasts around 25% of the limited partner (LP) base for established managers1. European LPs have the most liquidity of any region globally with much of the appetite directed towards North American Managers.
However, navigating the complexities the regulatory framework can be daunting, which is why we recently interviewed Paul Spendiff, Head of Business Development for Fund Services at Ocorian, to answer your commonly asked questions about raising capital in Europe.
What does the EU regulatory landscape look like for alternative investment funds?
There are a number of European regulations which can directly or indirectly impact the process of setting up and distributing funds across Europe.
- Cross Border Distribution rules.
- ESMA pre-marketing rules
We take a look at the key pieces of legislation below.
What is AIFMD and who is affected?
Alternative Investment Fund Managers' Directive (AIFMD) is a set of regulations introduced by the EU in response to the financial crisis. It covers not only European domiciled managers but also managers outside of Europe that manage either European AIFs or want to sell non-European AIFs into the Union.
AIFMD requires an alternative investment fund (AIF) of a certain size to have an Alternative Investment Fund Manager (AIFM). Simply put, the AIFM is a management company whose business it is to manage an AIF and take care of the portfolio and risk management of the fund. European distribution is now mainly controlled under AIMFD.
The threshold for applicability is assets under management of over 100 million or a higher threshold if all of the funds managed are unlevered and do not provide redemption prior to five years.
Managers of funds that are not alternative investment funds (AIFs) are exempt from AIFMD. However, unless a fund is very small, it is generally best to think about having an AIFM in relation to that fund.
How does AIFMD apply to fund distribution?
European distribution is largely controlled under AIMFD. Two main distribution routes are set out. These are:
- Passporting - A passport permits an EU AIFM to market a fund that it manages to professional investors in the home member state of the AIFM as well as other EU member states.
- Article 42 - If the AIFM and the AIF are based outside of Europe, the AIFM can register to conduct marketing activities with a member state. There is a wide variation in how easy it is to register and operate with each member state.
How does AIFMD apply to US fund managers?
Whilst it is technically possible for US-domiciled managers to be AIFMs to a European AIF or to a non-EEA (offshore) AIF that is sold into the Union it means they will be severely limited in how that fund can be distributed under article 42.
If they want to take advantage of certain provisions, particularly around the marketing of the fund, they will need a European-domiciled AIFM and a European-domiciled AIF to do so.
US fund managers seeking to raise capital in Europe should be aware of AIFMD, become comfortable with it, and be conscious of the overarching structures.
Does AIFMD apply to the UK?
AIFMD is a European directive, and as the UK is no longer part of the European Union, the original directive does not apply.
However, the UK has maintained its provisions that were adopted into National Law under AIFMD prior to Brexit. Essentially, there are two regimes that are quite similar, but UK managers are not EU AIFMs, and they cannot get a passport using a UK manager. They will have to make their registrations in various jurisdictions, and they cannot use their UK entity under the AIFMD passports for marketing.
What is the Cross-Border Fund Distribution Directive?
Introduced in August 2021, the Cross-Border Fund Distribution Directive is a regulatory framework designed to harmonise regulations across member states of the European Union.
One key provision of the directive is the concept of pre-marketing, which refers to providing information related to a strategy for an AIF that has not yet been established.
It states that all AIFMS (EU or non EU) marketing or intending to market any AIFs to retail investors must establish a local facility in each of the host members states where it is marketing the AIF to retail investors.
For those targeting professional or institutional investors, they do not need this facility but must register the fund in those markets it subsequently wants to rely on reverse solicitation in the following 18 months.
What are the ESMA pre-marketing rules?
Following the introduction of CBDF rules in 2021, additional content requirements for marketing materials being shared with EEA investors were set out in the ESMA Guidelines on Marketing Communications which came into effect on 2nd January 2022.
The ESMA guidelines set out expectations that pre-marketing materials (such as a teaser, presentation or pitch book) now comply with some of the guidelines such as the fair, clear and not misleading clauses.
What are the three primary ways to distribute funds in Europe?
The three primary ways to distribute funds in Europe are:
- Reverse solicitation - reverse solicitation is the least intrusive method and involves responding to unsolicited requests from investors.
- Private placement - private placement is a common method used by U.S. managers and involves country-by-country regulation compliance.
- AIFMD passport - the AIFMD passport allows managers to market their funds across the entire European Union, but is only available to those who meet specific requirements.
What is the most likely regime for US managers to use when distributing funds in Europe?
Private placement is the most likely regime for US managers to use when distributing funds in Europe, especially for their first foray into the market. Private placement involves complying with each country's regulations and can vary in difficulty depending on the country.
Some countries are still very much open to distribution under National Private Placement Regime (NPPR) whilst others have made it extremely difficult, if not near impossible to register non-EU funds for distribution.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.