Many European investors – and US and Asian real estate fund managers to an even greater degree – were left disappointed at the end of July when the European Securities and Markets Authority (ESMA) declined to issue an opinion on whether managers based in the US, Singapore and Hong Kong should be awarded a pan-EU marketing passport.
Currently European fund managers authorized under the Alternative Investment Fund Managers Directive (AIFMD) can market their funds freely among all other EU member nations. The idea was that this marketing freedom be extended to fund managers outside of Europe if they are subject to an equivalent level of regulatory scrutiny.
Popular private real estate fund domiciles Jersey, Guernsey and Switzerland have been recommended for inclusion by ESMA in the regime, as the regulator didn’t find any “significant obstacles” regarding investor protection, competition, or market disruption in these territories.
However, ESMA declined to give an opinion on the US, Singapore and Hong Kong “due to concerns related to competition, regulatory issues and a lack of sufficient evidence to properly assess the relevant criteria.”
With its inaction, ESMA made a significant statement about how granting the passport to US managers would cement an uneven playing field for European managers seeking to market their vehicles in the US. Lawyers have suggested onerous requirements that come with registration with the US Securities and Exchange Commission factored heavily into the decision.
The indecision of ESMA has let down both US and Asian fund managers that wanted a more streamlined approach to garnering capital in ‘Fortress Europe.’ Also lamenting the decision are European institutional investors.
Many European investors have been left disappointed that access to some of the best US and Asian real estate fund managers has been effectively closed, as not all fund managers located outside of the EU have felt the need to go through the rigmarole of marketing in Europe.
This is because until non-EU fund managers are able to opt into the AIFMD they must navigate a patchwork regulatory environment requiring a country-by-country analysis of the new marketing rules in each EU country. Additionally, some nations have gone above and beyond what the AIFMD requires when updating their local marketing rules, creating even more burdensome regimes for non-EU managers.
Some of those fund managers on the fundraising trail have told PERE that they will not market in Europe due to the extra costs and administrative burden. Placement agents on the continent have also bemoaned a lack of business as fund managers look outside of Europe to raise capital.
Some fund managers that rely on collecting at least some cash from Europe, but are intent to avoid being seen as marketing by regulators, have been taking their chances with ‘reverse solicitation’ – which allows non-EU managers to bypass the directive’s requirements if an investor reaches out first about a fund opportunity. However, legal sources said this strategy carries substantial risk, firstly because nearly all EU member states have neglected to produce any clear guidance on what constitutes reverse solicitation, and just as importantly, what does not.
Aside from the challenge around defining reverse solicitation, legal advisors are highlighting other major hazards in the strategy. One is investor risk. If a fund turns sour, an investor may say they were not the ones to initiate contact, meaning reverse solicitation never actually took place, and they therefore should no longer have certain legal obligations to the fund, like honoring capital call commitments. In some cases, investors could even look to recover their investments.
To combat this, some non-EU fund managers with sufficient scale are deciding that they cannot wait for ESMA to give them access to a marketing passport. Instead they are establishing EU-domiciled parallel funds authorized under AIFMD, granting them access to the pan-EU marketing passport.
For smaller non-EU fund managers unable to set-up a European conduit, the extension of the passport remains absolutely critical. But, due to the complex regulatory environment as well as the political headwinds that ESMA must navigate to extend the passport, sources expect such managers may be in for quite a long wait.