Absolutely Insufferably Fundamentally Materially Defective (the AIFMD)

We have been considering writing an article along these lines for around a year or so. However, every time that we were about to put pen to paper, we were stopped short by either something (AIFMD-related) even more absurd than what we had previously seen occurring, or a lull in time where we (mistakenly) believed that things were finally coming good. Alas, it is now the start of 2015 and the "good" has not come and therefore, in the spirit of sharing, this article has finally been written. Please note the purpose of this article (rant?) may be viewed as twofold:

1. we simply needed to get some frustrations off our chest (and find out whether we are a lone voice in the crowd); and
2. to give the industry some comfort that, to some extent, complying with the AIFMD is extremely difficult and at times a "finger-inthe- air job".

Accordingly, we hope that this article is read in the spirit in which it is meant. It is not intended to beat up ESMA, or indeed any local regulators, but merely to highlight quite how difficult it is to implement directives such as this in a short time-frame and that some emergency repair work may be needed.

A bit of background

To recap, the AIFMD (Alternative Investment Fund Managers Directive) officially came into force on 22 July 2013. For all intents and purposes (and as a great oversimplification), there was a one-year transitional period up to 22 July 2014 where the AIFMD could have perhaps been viewed as being only softly in place. However, since 22 July 2014, the AIFMD must be complied with in the EEA and broadly requires that:

• European fund managers are regulated under (and comply fully with) the AIFMD; and
• non-European managers that want to "market" their funds into the EEA comply with the disclosure and transparency requirements of the directive.

The straw that broke the camel's back

The following anecdote might be the reason why we finally "broke" and wrote this article.

On 9 January 2015, ESMA published a revised version of its "Questions and Answers" in respect of the application of the AIFMD (ESMA/2015/11). This is generally a very helpful publication. However, at question 50, ESMA responds to a query on how an AIFM should report information in relation to subscriptions and redemptions over the reporting period. The answer is simple: "AIFMs should report the value of subscription and redemption orders and not the number of subscription and redemption orders".

On the face of it, this is a very sensible answer. However, ESMA's response comes some time after certain managers have been required to report information to regulators, not always in this way. Further, we know that ESMA itself had previously told some fund managers who had gone out of their way to ask the very same question that the redemptions and subscriptions should detail the number of subscriptions/redemptions rather than the dollar amount. Confused? Many are.

Below, we have highlighted some of our other favourite nits to pick in relation to the AIFMD.

The EU "marketing passport"

The marketing passport is probably the most positive aspect of the AIFMD. It allows a European fund manager who manages a European fund to market this fund into other EEA states to professional investors by simply filling in a passporting form and sending it to their local regulator who will onwardly submit such a request to the other relevant EEA regulators. The beauty of the passport is that it means that an AIFMD regulated fund manager need only think about complying with the AIFMD rules (as implemented in its local jurisdiction) in order to be free to market into the rest of Europe (avoiding the need to take advice in each jurisdiction and/or complying with various restrictive private placement regimes). So far, so good.

It appears, however, that the AMF (the French regulator) has gold-plated the passport requirement (and note that there are no provisions within the AIFMD that allow this requirement to be goldplated) by requiring that a non-French EEA AIFM that wishes to market a fund into France (via a passport) must appoint a centralising agent/correspondent in order to do so. Such an entity must be domiciled in France. This requirement has, therefore, lead to confusion and inefficiencies in relation to operating the passport. ESMA has remained silent on whether they consider this permissible under the AIFMD. More importantly, if measures such as this are allowed, it renders the whole idea of a cross-border marketing passport (and, indeed, opening up such a passport to non- European managers) as practically pointless.

The definition of "marketing" under the AIFMD

"Marketing" is defined under the AIFMD as "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".

In our view, there are therefore two central strands to the definition of marketing under the AIFMD:

• it must be an offer or placement; and
• the offer must be by or on behalf of the AIFM.

Both of these strands make sense. If a fund manager is not directly offering a fund (but rather talking about its fund manager capabilities as a whole, as an example) then it is surely not marketing (offering) a fund. Further, it must be possible to talk about or detail a fund without doing so, meaning that there has been an "offer" made in relation to such a fund. To stress this point, if someone with no connection to a fund manager recommends a fund to their client (and such a person has, for example, an advisory relationship with its client) then it cannot be said that in doing so that person is making an offer on behalf of the AIFM (it has nothing to do with the AIFM and is simply offering services in its underlying clients' best interest).

However, it is not quite so simple. Accordingly, the points below highlight our understanding of the different approaches to marketing in certain member states:

• The UK adopts a literal interpretation of the AIFMD definitions. Therefore (and see, for example, related FCA PERG guidance) draft documentation is unlikely to fall within the meaning of offer, nor are documents that cannot be used by a potential investor to make an investment in an AIF.
• The Dutch adopt a similar approach to the UK position. However, there is no local guidance as to the meaning of marketing or pre-marketing in Holland. In Holland, provided there is no offer, something is unlikely (but this is not definite) to constitute marketing.
• We are not aware of any guidance issued in Ireland on what "marketing" or reverse solicitation mean under the AIFMD. However, the good news is that we understand that the Irish central bank is adopting a sensible approach (and/or following what the FCA (in the UK) does).
• The German approach is perhaps the most scientific. Broadly speaking, providing that no fund exists or is "marketable", any communications in relation to such are unlikely to constitute marketing. However, the flip side of this is that as soon as a fund does exist (and is therefore "marketable") any communications that mention the fund are likely to constitute marketing under the directive (no matter who has made them, how they are made, or in what capacity they are acting).
• The Swedish approach is perhaps the most interesting. Sweden has adopted a far wider definition of marketing than what is detailed above. Crudely put, this article probably constitutes us marketing several funds into Sweden!
• France. Again, there is no defined term as to what constitutes marketing in France. However, on different occasions, the AMF has defined marketing as a presentation of a financial instrument by different means with a view to encouraging a potential investor to subscribe/buy the financial instrument. This means that sending brochures and presentations to potential investors in France is likely to be considered as marketing in France, especially if an end investment comes about as a result of such activities.

The material difficulty with the different views is that it creates inefficiencies. Indeed, "cap-intro" services (as an example) and investor advisers struggle to understand in which countries they can carry out their activities without potentially bringing unconnected fund managers and funds into the scope of the AIFMD.

Non-European Private Placement rules

Under AIFMD, a non-European manager may market a fund into the EEA if it complies with the local private placement rules (which have been amended as a result of the AIFMD) for each EEA jurisdiction where it wishes to market. This is commonly referred to as the "Article 42" notification process. In some respects this process is working; it is broadly possible to market a fund into Europe using the Article 42 notification procedure.

However, the following bugbears exist:

• the "approval" time-frame in each jurisdiction varies dramatically. For example, the FCA in the UK has generally been approving marketing notifications within a day or so (although recent applications appear to be taking quite a lot longer). This should be compared to the German (BaFin) process, where approval to market a professional fund is taking more than three months (and a similar length of time to prepare the required application). There is also little consistency in the approach taken by some national regulators; we have seen one regulator approve a request within two weeks for one fund and then take six months for another fund where there has been no material difference in the applications.
• The above issues are also complicated by a "chicken and egg" problem that appears in many member states. Certain regulators require final form documents in order to approve an Article 42 notification. This can be particularly difficult in relation to closed-ended funds where investor documents (for example, subscription agreements and limited partnership agreements) are heavily negotiated with potential investors. Further, if providing such documents constitutes "marketing" in the relevant member state (as detailed above) how can fund managers provide these documents to an investor in order to negotiate them and not breach "marketing" requirements in the member states and still be able to provide the relevant regulator with final form documents for the regulators' approval. For some questions it appears there are no answers…
• Despite the Article 42 notification process broadly working in most member states, a couple of problem member states remain. Currently, we understand that there is no Article 42-type notification procedure for non-European funds that wish to market into Italy. While there is such a procedure for France, it appears so arduous that we are not aware of any manager who has successfully completed the process. In such jurisdictions, many managers are relying on reverse solicitation-type concepts even though the relevant regulators have provided little comfort on the availability and use of such safe harbour.

AIFMD "regulator reporting"

A fund manager's problems are further compounded when, after navigating the quagmire of the marketing rules, they are then faced with AIFMD regulator reporting requirements.

Without wishing to go into too much detail on the topic (because it may bring about sleep!), the following list demonstrates some of the problems relating to regulator reporting that currently exists across various member states:

• We have a client who applied to market into a certain member state a few months ago. At a later date, we asked the regulator how the relevant reporting forms should be sent to them. Initially, the regulator said that they had never received our notification (which was worrisome). On being pushed further on this point, the regulator back-tracked and said that they had found it but were "only working through them now" (which was odd because we had been given permission to market). We then asked them how we should go about reporting to them (i.e. which forms they want and through which channels). The short answer was "we don't know".
• Reporting requires AIFM and AIF codes/numbers. Unfortunately, there is a completely mixed response from European regulators as to what they expect in relation to these details. Some appear to want a number that they supply to you when you notify (although we have had instances when the number was never supplied) while others seem to want a number provided by the (non-EEA) home state regulator (with no answer to the question as to what happens if you do not have a home state regulator or have never been given such a number).
• As has been detailed above, there are also different views between leading regulators (such as the FCA) on how reporting cells are to be completed. Interestingly, it was the FCA that led with the view that the monetary value of subscriptions, redemptions should be supplied and not the amount of investors (which previously ESMA had indicated it wanted). The moral of this story might be that, when in doubt, choose the approach that seems to make the most sense!
• Certain member states have also developed their own form of reporting template. While such forms are similar to those set out by ESMA, they also require separate reporting to be given in respect of the manager's financial soundness (looking far more like a balance sheet-type report relating to the manager than anything relating to the underlying fund). This clearly increases the ongoing compliance burdens on the manager.
• Lastly, certain member states are not in a position to accept reports at the moment. However, there is not a list of regulators that this applies to. The only way to find out is to seek out someone at the appropriate regulator who is sufficiently knowledgeable to give the answer or simply choose which Chinese whispers you are most comfortable listening to.

Finally, a word of warning, if you are about to submit any AIFMD management or marketing passport applications to regulators in relation to sub-funds or compartments, please ensure you have had a stiff drink first. We'd be happy to join you at the bar!

Roll on MIFID II implementation…