Introduction

In the dynamic world of financial investment, understanding the regulatory frameworks governing investment entities and collective investment schemes is crucial. This article aims to provide insights into the intricacies of the Directive 2011/61/EU on Alternative Investment Fund Managers (AIFMD) and its impact on investment strategies and structures.

Definition of Investment Funds

Collective investment schemes or (alternative) investment funds are entities pooling capital from various investors to invest for their benefit in line with a predetermined strategy. These funds, distinct from operational companies in the non-financial sector, form the cornerstone of AIFMD's regulatory scope.

The Concept of an 'Undertaking' in Investment Funds

The term 'undertaking' remains broadly defined in the AIFM Directive. According to ESMA guidelines (ESMA/2013/611), an organism or undertaking in this context refers to a legal or economically independent entity pooling external capital. Importantly, joint venture agreements lacking this pooling characteristic do not qualify as organisms.

Contrary to common assumption, the legal form of an investment fund is not a determining factor for its classification as an undertaking. This inclusivity extends to various legal structures, such as corporations, partnerships, or civil law associations, encompassing all conceivable forms under the AIFM Directive. While various legal forms are recognized for investment funds, the suitability of these forms for regulatory approval is a separate matter. The legislation specifies certain forms that are preferred for launching investment funds.

Furthermore, the form of investor participation is irrelevant. Whether through equity, membership, or contractual obligations, any form of investor involvement is eligible. This broad interpretation ensures a wide-ranging applicability of the term 'undertaking' within the scope of the AIFMD.

Criteria for Collective Investment

For a vehicle to be considered for collective investments, according to ESMA guidelines, it must pool external capital from investors to generate a communal or joint return. This involves sharing risks and rewards from asset transactions. Such a collective or joint investment is identified when investors share in the undertaking's fortunes, determined by the net value of its assets and liabilities. This includes cases where an investor's profit or loss participation is contractually limited, emphasizing the non-fixed nature of returns. If an investor has an unconditional capital repayment claim, e.g., even in case of a qualified subordination agreements, it does not constitute a collective investment. Certain arrangements, such as minimum payment guarantees however, do not negate the presence of a collective investment. These arrangements merely provide a secondary layer of protection against loss participation for the investor.

Illustrative Examples of Various Investment Forms

  • Partnerships
    • Capital contributions made by partners typically fulfill the criteria for collective investments due to the inherent profit and loss sharing.
  • Silent Partnerships, Profit Participation Rights, and Registered Bonds
    • In silent partnerships, the investor's participation in profits and losses usually meets the collective investment criteria. However, variations in the specifics of these arrangements might influence their classification.

Capital Collection or Raising of Capital as a Constitutive Element

The AIFMD necessitates that an investment entity must engage in the raising of capital from a number of investors. As per ESMA's guidelines, this involves direct or indirect efforts by an entity, or on behalf of it, to commercially procure capital from one or more investors, with the intent of investing it in accordance with a predefined investment strategy.

The AIFM Directive's Recital 7 exempts certain entities, such as family office vehicles managing private family wealth without raising external capital (e.g., from friends), from being classified as AIFs. This exemption is grounded in the principle that if a family initiates an investment vehicle for internal purposes, it doesn't engage in commercial solicitation. ESMA guidelines reflect this view by categorizing such family offices as "pre-existing groups", thus not fulfilling the "capital raising" criterion. Here, 'family' encompasses spouses, life partners, and immediate relatives like parents, siblings, children, nephews, nieces, grandchildren, uncles, aunts, first cousins, and their respective survivors.

Investment clubs, under certain strict conditions, may also be exempt from the "raising of capital" requirement. These clubs are formed by natural persons pooling private assets for investment in securities or other financial instruments. If none of the members are commercially solicited, and the club refrains from publicly seeking additional members, then it is likely not engaged in raising, collection or pooling of capital and, thus, would not be classified as an investment entity.

Multiple Investors

According to Art. 4 para. 1(a) AIFMD a number of investors is required and established if the investment terms, statute, or partnership agreement of the investment entity do not limit the number of investors to one. The actual number of involved investors is irrelevant; the theoretical possibility of multiple investors suffices. Conversely, if the investment terms or governing documents explicitly prohibit additional investors, the criterion of "a number of investors" is not met.

When multiple investors participate via a trustee, the presence of multiple investors is still recognized, even if the governing documents only permit the trustee as the investor. In such cases, ESMA proposes a substantive approach looking through the trustee to the underlying investors.

Defined Investment Policy

A further requirement is that the investment entity must invest the pooled capital in accordance with a defined investment policy for the benefit of the investors. The AIFM Directive does not explicitly define "investment policy".

Per ESMA guidelines, an entity has a defined investment policy if it outlines how the pooled capital must be managed to generate a collective return for investors. Indicators of such a strategy in a policy include:

  • The policy is established by the time the investor's participation becomes binding;
  • It is detailed in a document that is part of the investment terms or statute of the entity, or referenced therein;
  • The entity has a legally binding and enforceable obligation to adhere to the strategy in the policy;
  • The policy specifies guidelines for investment (e.g., in certain asset categories, allocation restrictions, specific strategies, geographic regions, leverage limitations, holding periods, or risk diversification mandates).

The legislative rationale behind this stipulates that for an investment policy to be considered "defined", the criteria for capital investment must be specifically detailed in writing, beyond a general business strategy. This distinction ensures that the investment criteria are precisely defined, and the discretionary powers of the AIFM are constrained within the investment terms, statute, or partnership agreement.

Investment for the Benefit of Investors

An essential criterion stipulated by the AIFMD is that the collected capital must be invested "for the benefit of those investors", meaning it should not be utilized for the advantage of the entity's own business. For instance, if a bank issues a bond in the form of a certificate, linked to the performance of various securities or a self-created index, it does not constitute an investment for the benefit of investors if the bank retains discretion in using the investor's funds and does not commit to investing them in the assets underlying the index or reference portfolio. In such a scenario, the bank's primary objective is its own profit generation.

Exclusion of Operationally Active Companies Outside the Financial Sector

Another key element is the exclusion of "operationally active companies outside the financial sector" from collective investment schemes.

According to ESMA's guidelines on "general commercial or industrial purpose," companies that develop or construct real estate, produce goods and commodities, or provide services outside the financial sector are considered operationally active.

Additionally, companies relying on external service providers or group-affiliated entities for operational activities remain categorized as operationally active, as long as the decision-making authority in daily business operations rests within the company, enforced by explicit agreements on control, steering, and directive rights.

If an operationally active company also makes investments for asset purposes (e.g., in financial instruments), it is permissible as long as these activities are minor ancillary or supportive tasks.

Relevant examples in specific sectors are discussed below:

In the real estate sector, activities such as operating a property (e.g., a hotel or care facility), project development (conceptualizing, purchasing, developing, and eventually selling the developed property), as well as "facility management", brokerage, valuation services, or financial consulting related to real estate transactions are considered operational activities. In contrast, acquiring, renting, leasing, managing, and selling real estate are not deemed operational activities.

Source: BaFin Clarification letter on the scope of application of the KAGB and the term "investment fund"

Executive Summary:

  • Definition of investment funds: Investment funds are entities that pool investor capital for investment as per a defined strategy, not being operational companies in the non-financial sector.
  • Undertakings: A broad interpretation of 'undertakings' includes various legal structures and forms of investor participation.
  • Collective Investments Criteria: A collective investment is characterized by shared risks and returns, with no unconditional capital repayment claims.
  • Legal Forms and Approval: Various legal forms are recognized for investment funds, but not all are equally eligible for regulatory approval.
  • Capital Raising: Investment entities must actively collect capital from investors. Family offices and investment clubs, under certain conditions, are exempt from being categorized as investment entities if they do not engage in commercial capital raising activities.
  • Multiple Investors: The AIFMD requires investment entities to potentially allow a number of investors, not limiting to a single investor. The actual number of investors is irrelevant; what matters is the theoretical possibility of multiple investors.
  • Defined Investment Policy: Investment entities must have a clear, legally binding predetermined investment strategy, distinct from general business strategies or policies. This strategy must be documented and is enforceable by investors.
  • Investment for the Benefit of Investors: Entities must invest the pooled capital primarily for the benefit of the investors, not for the entity's own profit generation.
  • Exclusion of Operationally Active Companies Outside Financial Sector: Companies actively involved in commercial or industrial activities outside the financial sector are excluded from being classified as (alternative) investment funds.

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.