The EU's regime for how funds are marketed to professional investors across the EU has long been subject to calls for greater harmonization. The outgoing European Parliament on June 20, 2019 concluded its legislative procedure for the adoption of a Regulation and a Directive on facilitating cross-border distribution of collective investment funds which amends existing EU rules. The aim of these reforms are to make it easier, quicker and cheaper for EU asset managers to sell funds to a wider range of investors and thus for investment to flow better across the EU1, which is a core component of the EU's Capital Markets Union project. This Client Alert highlights the most important updates the new legislation has introduced. Detailed analysis can be provided upon request and some funds may want to take earlier action, not least given the changes that this development may mean for the UK versus the rest of the EU.
The two legal texts have just been published in the Official Journal2. Both legal acts add new rules for the cross-border distribution of alternative investment funds (AIFs) and undertakings for the collective investment in transferable securities (UCITS) in the EU. The rules will most likely take effect towards the end of 2021, given the standard 24-month implementation period. Broadly speaking, the Directive3 focuses on pre-marketing and de-notification procedures, while the Regulation4 looks at marketing communications and the information made available by national and EU regulators.
One of the core aims of the documents has clearly been to increase the level of harmonization of cross-border marketing between the alternative investment fund managers directive (AIFMD) and UCITS regimes. It could be argued that this aim has been mostly achieved. However, as one of the new documents is a Directive, which requires transposition by each Member State, how these new amendments are implemented remains key. This is especially likely to be the case in the context of Brexit, and current uncertainty in the future relationship of the EU 27 towards the UK, given that the gatekeeper of these rules, the European Securities and Markets Authority (ESMA), will have to keep a close eye on certain jurisdictions that compete with one another to attract funds and/or their managers, to domicile within "their" jurisdiction.
Additionally, many of the provisions introduced by these reforms apply only to EU alternative investment fund managers (AIFMs), thereby excluding non-EU managers or sub-threshold managers. This may change with the review of AIFMD scheduled for the end of 2019. Member States may also decide to apply the rules to both EU and non-EU managers. The potential outcome of this remains to be seen. Additionally, the new rules ensure that third parties marketing funds in the EU on behalf of an EU-authorized manager must be EU-regulated entities, something especially relevant in the context of Brexit, and an issue that might require a rethink by some fund managers on their Brexit-planning.
Lastly, the new rules introduce a requirement for the creation of central databases, via ESMA and to the extent these do not already exist in relevant Member States, on the national marketing requirements, applicable fees and charges and listing AIFs, UCITS, their respective managers and where the funds are marketed.
The Directive includes rules on pre-marketing of AIFs but also, more broadly, a harmonization of rules to provide "local facilities" applicable to both EU and non-EU AIFMs and UCITS marketed to retail investors. It also introduces a process of de-notification of marketing of an AIF or UCITS in a host Member State, as well as an alignment of certain notifications in respect of the marketing of an EU AIF or UCITS in a host Member State.
The pre-marketing rules apply to authorized EU AIFMs in respect of which an AIF is: (i) established but not yet notified for marketing; or (ii) not yet established at all. There is a definition of pre-marketing that would allow EU authorized fund managers to market a new fund to potential professional investors without a marketing application provided that they comply with the requirements included in the Directive. This allows an EU AIFM the ability to test the appetite of potential professional investors in a relevant EU target market and for the EU AIFM to take an informed commercial decision prior to entering that market. It should be noted, however, that where a professional investor in a Member State subscribes for units/shares in a pre-marketed AIF within 18 months of the AIFM starting to pre-market, this will be deemed the result of marketing and would be subject to notification. As such, reverse solicitation becomes potentially more problematic.
In terms of providing "local facilities", the rules dictate that all UCITS and, in order to ensure less fragmentation, all AIFMs, that are marketing or intending to market a UCITS or AIF to retail investors in an EU Member State, must make available information relevant to investors there, for example in terms of their rights, subscription, payment or repurchase orders and the tasks the facilities perform. The information can be made available electronically – there is no need for a physical presence like an office in the jurisdiction – and the facilities can be operated by a third party. Not only does this change harmonize the rules for UCITS funds and AIFs but removes the national variation in the previous rules. Previously the national legislative provisions that implemented the UCITS rules in most relevant Member States required that a person engaging in UCITS operations in the relevant jurisdiction had a facilities agent physically in that territory. In certain jurisdictions, the role of that local facilities agent was not only for making payment to unit-holders, repurchasing or redeeming units and serving as an information window, but also undertaking complaints handling, local interface with the local supervisors or even local distribution tasks. The reforms introduced by the present rules do away with these barriers to entry and are designed to harmonize the rules across the EU so that retail fund investors have access to uniform, high levels of customer service in the EU.
De-notification of marketing
The de-notification of marketing in a host Member State applies to all UCITS and EU AIFMs marketing EU AIFs that previously had to notify under Article 32 of the AIFMD. A UCITS or AIFM wishing to discontinue marketing is required to send a notice of de-notification to its home regulator, making a blanket offer to repurchase or redeem all units of the UCITS or AIFs (other than closed-ended AIFs and/or funds designated as European Long-Term Investment Funds (ELTIFs)) being de-notified that are held by investors in that Member State, amongst other requirements. The notification and offer processes have prescribed timings, and it is important to note that the UCITS or AIFM is not allowed to engage in pre-marketing of units or shares of a de-notified UCITS or EU AIF, or one of similar investment strategies or ideas, in that host Member State for 36 months after the date of de-notification. The phrase "similar investment strategies or ideas" can be especially problematic.
Alignment of notifications
Lastly, the notification rules applying to UCITS and authorized EU AIFMs has been aligned. The rules dictate that when a UCITS or an EU AIFM wants to market a UCITS/EU AIF in a host Member State, it must first notify its home regulator of its intention to do so and provide specified information. In the event of material changes, the manager must notify the regulator at least one month before implementing the change, after which the regulator will determine whether the manager would still be in compliance with UCITS or the AIFMD after implementing the change. If that is not the case, the regulator has to inform the AIFM within 15 working days.
The Regulation focuses on the requirements for marketing communications and their verification, as well as the requirements on ESMA and national competent authorities (NCAs) to publish and share information, including a central database of AIFs, UCITS and their managers.
The Regulation also extends the new pre-marketing and marketing communications regimes to European Venture Capital Funds (EuVECAs) and European Social Entrepreneurship Funds (EuSEFs).
The marketing communication requirements apply to UCITS and authorized (i.e. EU domiciled) AIFMs. The requirements follow the standard rules that marketing materials should be identifiable as such, must describe risks and rewards equally prominently and should be fair, clear and not misleading. These rules are not limited to communications with retail investors, as has historically been the case, but also apply to communications with professional investors.
For UCITS, there are also requirements to ensure that marketing communications do not contradict or diminish the significance of the fund's prospectus or KIID, and indicate where those documents and information on investors' rights are made available. This also applies to AIFs which publish prospectuses under the Prospectus Regulation and KIDs under the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation.
We expect these changes to prompt asset managers to undertake an internal-led compliance review of relevant documentation ahead of any supervisory scrutiny by either ESMA or NCAs, which have all indicated a greater interest in this area during the 2019 to 2021 supervisory lifecycle.
Similarly, the verification of marketing requirements also apply to UCITS and authorized AIFMs. The new rules allow NCAs to require prior notification of marketing materials in respect of UCITS and of AIFs that are to be marketed to retail investors.
Regulatory information and databases
The rules here apply to NCAs and ESMA. The rules provide for the publication by ESMA of a central database listing AIFs, UCITS and their managers, as well as a more coordinated exchange of information between NCAs and, in particular, between NCAs and ESMA (as central gatekeeper) on the notifications made by managers to the NCAs that relate to marketing communications and the verification requests made by NCAs, as well as the types of breach most frequently encountered in relation to the marketing communication requirements. ESMA is required to report to the European Parliament based on this evidence.
NCAs are required to publish current and complete information on their websites regarding:
- relevant and applicable national laws, regulations and administrative provisions governing marketing requirements for UCITS and AIFs, together with the (presumably non-binding) summaries of these, in at least a language "customary in the sphere of international finance". This may seem to make access to information easier, but we would flag that, as in other areas of EU financial markets with similar reform agendas, there is a risk of incorrect translations or translations out of context. Careful EU and local counsel level input is still going to be very relevant here.
- the NCA's supervisory fees and charges and where applicable calculation methodologies relevant to the supervision of cross-border activity of UCITS and AIFMs.
- all AIFs and UCITS, and the respective AIFMs and UCITS management companies, marketed in a Member State other than the home Member State and the Member States in which they are marketed.
The texts show some welcome improvements, although they are not without fault.
The new pre-marketing rules are helpful, but will need to be navigated carefully as highlighted earlier in this Client Alert.
Non-EU AIFMs would be hard pressed to see a difference once the rules come into effect unless Member States decide to make equivalent changes to cater for non-EU AIFMs and their funds, and/or the EU replaces the current National Private Placement Regimes for non-EU asset managers marketing into the EU to the more harmonized route, a proposal which has been stalled for some time. The changes may at least prompt non-EU asset managers to assess the efficiency of their distribution options into the EU (including the UK).
Ultimately, the European Commission hopes that, by removing perceived inefficiencies, the cost for cross-border distribution will be reduced and made simpler and quicker, thereby allowing for more marketing of funds across the EU. It remains to be seen whether this will be the case.
What is certain is that affected asset managers should strategically assess how these changes will impact them, may need to reassess and potentially redraft existing fund documentation, internal policies and procedures as well as possibly notify investors of the respective changes. Equally, such changes may drive efficiencies in their distribution models.
How this impacts UK managers and distribution of funds between the UK and EU 27 is still largely dependent on the outcomes to Brexit negotiations.
Our dedicated European regulatory team will continue to monitor the situation, provide timely updates as new information becomes available and offer pertinent advice when requested.
1. In terms of putting this into numbers, the EU estimated in February 2019 that the EU investment funds market (including the UK) amounts to a total of €14.3 trillion. This, however, does not represent a fully integrated market, as 70% of the total assets under management are held by investment funds that are authorized or registered for distribution only in their domestic market. Only 37% of UCITS and only a staggering 3% of AIFs are currently registered for distribution in more than three EU Member States. ↩
Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com.
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.