After the maelstrom of the 2008 global financial crisis, politicians and securities watchdogs looked to shore up what was considered a lax regulatory environment within the financial sector. For Europe’s private funds sector, the result was 2011’s Alternative Investment Fund Managers Directive (AIFMD).
The rationale for the pan-European regulation was to harmonize the oversight of private fund managers in Europe and increase investor protection. However, such a grand undertaking on an industry that had hitherto been largely unregulated ran into complications. Both European-based real estate investment managers and investors have been left disappointed by the regulation which they call too bureaucratic, over-complicated, and costly.
European investors too have a particular complaint: access to some of the best US and Asian real estate fund managers is effectively closed. As non-EU fund managers are unable to opt into the AIFMD, and are therefore required to navigate a patchwork regulatory environment which requires a country-by-country analysis of new marketing rules, many have simply stopped coming to Europe to market their funds. Placement agents on the continent have also bemoaned a lack of business as fund managers look outside of Europe to raise capital.
Acutely aware of the issue, Europe’s financial regulator, the European Securities and Markets Authority (ESMA), is trying to change that. ESMA last month issued advice to the EU, arguing that 12 non-EU countries should be afforded the pan-EU marketing passport provided by the AIFMD.
ESMA’s advice may also be encouraging to the UK in terms of its options once it has exited the EU. In a post-Brexit world, the UK should be seen by ESMA to operate an equivalent regime to the AIFMD and sources say it is hard to see on what legal grounds the passport should not be extended to the UK. Yet others say there may be a political dimension which comes into play about whether the EU would be prepared to extend the directive to the UK. Judging by the general rhetoric from European bureaucrats towards the UK post-Brexit, it would be fair to bet such an offer might not be so forthcoming.
In any event, ESMA has said that the EU should consider waiting until the regulator has given positive advice on more countries before triggering the extension of the passport to non-EU countries and the timetable for implementation of a third-country passport is unclear.
The next batch of countries for ESMA’s assessment is likely to include the Bahamas, Brazil, British Virgin Islands, Curacao, Mexico, Mauritius, South Africa, South Korea and the US Virgin Islands, which ESMA has identified as the other most relevant domiciles for this process.
European investors are still being stymied by the AIFMD and will need to find ways to legally work around the current marketing burden. Some investors, for instance, are relying on the concept known as ‘reverse solicitation’ – which allows non-EU managers to bypass the directive’s requirements if an investor reaches out first about a fund opportunity.
However, making fund managers even more nervous about working with an investor looking to exploit reverse solicitation is that if a fund turns sour, an investor may renege and say they were not the ones to initiate contact. In such a case, there would be no legal obligations to the fund, like honoring capital call commitments. In some cases, investors could even look to recover their investments.
For many of the global players with sufficient scale, they 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.
Yet, most smaller non-EU fund managers are unable to set-up a European conduit and European investors continue to lament the lack of fund manager options, making the extension of the passport absolutely critical. So, while ESMA’s announcement is a definitive step in the right direction, many are being forced to keep impatiently waiting.