The EU Cross Border Distribution Fund Directive 2019/1160 — also known as the CBDFD, CBDF, or the Directive — along with EU Regulation 2019/1156, were issued to remove regulatory confusion and complications of cross-border marketing of alternative investment funds (AIFs) within the EU, which in large part was due to differing member state implementations of marketing under the Alternative Investment Fund Managers Directive (AIFMD).
For the sake of simplicity, let’s bundle this new set of guidelines together as the “Pre-Marketing Rules,” or simpler yet, “The Rules.”
What is the key take-away from these Rules? In short, investment managers promoting AIFs can no longer pre-market their fund, investment strategies or investment ideas to get a sense of investor appetite without a notification to relevant event national regulators. This includes situations where EU investors have long-standing relationships and are even already investors in a manager’s existing funds.
Given that pre-marketing is a new regime within AIFMD, here is a refresher on what pre-marketing means under the Rules:
- provision of information on investment strategies or investment ideas by, or on behalf of, an EU AIFM;
- to prospective professional investors domiciled or with their registered office in the EU;
- to test investors’ interest in an EU AIF which is not yet established, or not yet notified for marketing to the relevant EU member state regulator; and
- the provision of information must not amount to an offer or placement to the investor.
It is important to point out that the Rules only apply to EU alternative investment fund managers (AIFMs) managing EU AIFs. They do not apply to non-EU AIF promoters and non-EU AIFMs marketing funds under Article 42 of AIFMD, the national private placement regimes (NPPRs), nor do they apply to non-EU AIFMs managing non-EU AIFs who rely on reverse solicitation. However, this is where reverse solicitation starts to get problematic. It is now in the crosshairs of regulators.
In January of last year, the European Securities and Markets Authority (ESMA) published a memo reminding non-EU firms on the principles of “reverse solicitation”. Reverse solicitation allows third-country firms, including UK firms, to service EU clients without triggering local licensing requirements. This requires, however, that the client in the EU initiates, “at its own exclusive initiative” the business relationship with the third-country firm.
ESMA specifically highlighted that it had become aware that, since December 31, 2020: “…some questionable practices by non-EU-27/EEA firms around reverse solicitation have emerged.” ESMA goes on further to highlight “the provision of investment services in the EU without proper authorization in accordance with the EU and the national law applicable in Member States exposes service providers to the risk of administrative or criminal proceedings.”
What does this mean for reverse solicitation and U.S. managers that rely on it? It comes as no surprise that many U.S. managers seek to bypass the full scope of AIFMD by not marketing to EU investors. Instead, they wait for EU investors to approach them about their fund offerings. Even years after the implementation of AIFMD, this still remains the main way U.S. managers engage with EU investors. Of course, AIFMD did not previously restrict professional investors who wanted to invest in AIFs on their own initiative. The Rules change this.
For 18 months after an AIFM has started pre-marketing, any new subscription from a professional investor will be deemed to have been the result of marketing and shall be subject to the already applicable AIFMD marketing notification procedure. Or in other words, the European Securities and Markets Authority (ESMA) will consider any new subscription to be regulated under the full scope of AIFMD – and in their own words – expose managers to the risk of administrative or criminal proceedings.
Given this increased regulatory scrutiny by ESMA and member state regulators, U.S. managers will want to ensure that their go to market approaches comply with these new expectations.
Furthermore, ESMA have published their AIFMD II proposals. The references in AIFMD for third country entities to comply with FATF listings and OECD tax exchange agreements are to be updated and replaced with a requirement that they are not domiciled in a non-cooperative jurisdiction as defined by the EU Council from a tax perspective, and that they are not domiciled in a third country identified by the EU as a high-risk third country for AML purposes.
This is a significant change. EU investors will be encouraged to steer away from jurisdictions that are on the list but also from jurisdictions that might end up on the EU list.
In conclusion, it is obvious that legislative, legal and regulatory frameworks that were originally used as the basis for capital raising, and investment have changed. US fund managers relying on reverse solicitation and other alternative fundraising efforts to reach European investors unnecessarily risk increased scrutiny and potential civil and criminal liability.
This article was first published in Alternatives Watch in May 2022 here.