The use of established third-party platforms has become increasingly popular for asset managers launching UCITS in recent years. The indicators are that this trend is likely to be even more pronounced among managers seeking to establish alternative funds in compliance with the EU’s Alternative Investment Fund Managers Directive (AIFMD). This article provides an overview of some of the key considerations when negotiating to “on-board” onto an existing third-party platform in either the UCITS or AIFMD environments.

Overview

Third-party platforms are generally umbrella fund structures established by investment managers or promoters, including distributors, which allow other previously unaffiliated (sub-)investment managers to essentially “plug and play” by joining the platform with their own separately managed sub-fund. The sector has grown massively in recent years as the cost and complications involved in a new launch have expanded, and as managers have sought to access new markets for distribution through the use of more complex on-shore regulated products.

Pros and cons

There is a range of both advantages and disadvantages to joining a platform rather than establishing a new stand-alone fund.

Advantages

• Cost savings – often cited as one of the main advantages of the platform route, platform’s allow certain fixed overheads and costs (such as directors’ fees) to be spread across several funds. A platform should also be able to take advantage of economies of scale and collective bargaining power to obtain lower fee rates from service providers.
• Access to capital base– UCITS promoters in Ireland are obliged to prove a minimum capital base of €635,000 in order to be approved to act by the Central Bank of Ireland (Central Bank) and smaller managers without this level of capital may find a platform an attractive solution to meet this requirement and, in some cases, the only practical means of proceeding to launch.
• Speed to market – launching a single new sub-fund on an established structure should be quicker and a more efficient project to manage and complete than a completely new launch.
• Distribution – an established distribution network and the potential for introductions to new sources of capital are also key attractions promoted by platforms. The platform itself may be an established brand.
• For alternative funds, a third-party platform will typically include the appointment of an authorised EU-domiciled AIFM on an EU-domiciled alternative investment fund (AIF) umbrella. New sub-funds on the platform will therefore be able take advantage of the AIFMD passport, even where the underlying portfolio manager is located in a non-EEA country such as the United States.
• Know-how – obtaining access to the platform managers’ general know-how regarding the launch process, product specifics and local market knowledge for distribution purposes is often highly valued by those using platforms in order to enter a specific regulatory space (e.g. UCITS) for the first time.
• Responsibility for compliance and corporate governance – the manner in which platforms can take primary responsibility for a significant portion of the on-going compliance, regulatory and corporate governance requirements inherent in the post launch operations of UCITS- and AIFMD-compliant funds can be a key attraction as it essentially frees the manager to focus on portfolio management.

Disadvantages

• Cost – with fees calculated on an AUM basis, platforms may be prohibitively expensive once a certain size is achieved. Performing cost analysis based on a number of permutations regarding expected size and the life of the fund is highly advisable. Even for smaller managers, the potential to capitalise on keen pricing from service providers eager to maintain relationships or to expand, may provide a competitive alternative. Costs inherent in the on-boarding process can easily equal those of a new launch.
• Control – joining a platform essentially means that a portfolio manager is a service provider well removed from the core of a fund structure and is unlikely to have any representation on the board. Appointment would be subject to termination in accordance with the terms of the sub-investment management (or other) agreement appointing it.
• Choice of service providers – setting up a fund on a stand-alone basis ensures that the asset manager is free to choose the other service providers to that fund. The know-how of platform managers comes at a cost over the life of the fund, but should be equally available as part of the service provided by local lawyers, fund consultants and other service providers.

Key terms for the “on-boarding”  

Fees and expenses

Cost is frequently touted as a reason to go onto a platform rather than launch a stand-alone fund. However, calculating the all-in cost can be challenging as a range of charges may apply for different services provided – potentially leading to significantly higher overall costs in practice than the headline figure initially anticipated. Accordingly, it is useful to model the TER at different AUMs based on a range of assumptions, as well as seeking to identify hidden costs (for example, tied service providers affiliated with the platform sponsor). The basis for the imposition of fees is also key - different fee levels should apply depending on whether subscriptions are obtained through the platform’s distribution channels.

Some platforms seek an initial on-boarding fee or even require a termination fee. These can be viewed in much the same manner as subscription and redemption charges for fund investors. As such, they may be acceptable in the context of securing key terms that satisfy the manager’s longer-term goals, such as agreement to a fixed term. A manager joining a platform may also seek reciprocal terms where it is to be ejected from a platform.

A platform may also have compulsory policies relating to matters such as soft dollar commissions or expenses which impact on the relevant economics.

Termination

Termination provisions are critically important for managers, especially where use of a platform is a medium-term measure while initially assessing a market or growing a fund to a certain size. In such cases it is essential that the contract reflects the manager’s intention to exit the platform at some future time. However, both the investment manager and sub-investment manager are merely service providers to the structure to which they are appointed. Therefore, even if there is no longer-term plan to set up a new stand-alone fund, managers need to ensure that the termination provisions in the agreement with the platform minimise the potential for such managers to be ejected from the platform against their wishes (whether or not this is followed by being replaced by a rival manager with a similar strategy).

A manager leaving a platform to set up a stand-alone fund will wish to bring existing investors along, use the track record built up while on the platform, and use the same or a similar name to the existing fund. The cleanest way in which a future move to an independent fund will be managed, and these aims achieved, should be addressed contractually when the manager is being on-boarded initially to assist in ensuring a smooth transition.

A departing manager will wish to retain goodwill built up by their sub-fund, to the greatest extent possible. Accordingly, apart from ensuring that the manager retains the (ideally exclusive) right to use the fund name, performance and investor records, it may be helpful to provide that, following the manager’s departure, the platform must: close the formerly managed fund, no longer use the fund name, and refrain from citing the manager’s performance data. Otherwise, there is a risk that the key value in the structure will be ascribed to the platform’s brand, rather than to the manager.

A transition may not be as smooth as anticipated. For example, the board of the fund may determine it is appropriate to withhold assets from proposed redemptions and delay a wind up of a sub-fund post-termination to provide for any contingent liabilities.

Assignment or change of control

Further to consideration of termination provisions, managers should be mindful of contractual provisions that could be drafted to address their other exit strategies. For example, many platform agreements will provide that a change of control constitutes an automatic termination event. In such a case, it may be difficult to realise the value of the manager’s business because such a clause will hinder or may even render a sale impossible.  Providing for a specific right of assignment may therefore useful.

Duration

Most platform agreements will be open-ended in duration. However, providing for a fixed term, with potential renewal rights, is worth considering, especially if: the manager expects to exit the platform and offer a stand-alone fund within a specific time frame.

Non-compete

Platforms may request the inclusion of non-compete provisions, at least within the same product range (e.g., UCITS). While such provisions may not seem relevant when initially signing up for a platform, they may become desirable once the manager is comfortable in the particular regulated environment or has identified its own investor base and is intending on transitioning into a new stand-alone fund, perhaps initially by establishing a stand-alone fund in parallel with the platform. Including a provision guaranteeing a certain capacity to the platform (addressed further below) instead of a non-compete clause may be a satisfactory compromise from the perspectives of both the manager and platform.

Conversely, the manager may, in turn, seek a non-compete provision from the platform with regard to rival sub-funds, as discussed further below.

Capacity

Some platforms may require that a manager guarantee an ability to service a certain capacity or level of assets. This can be a useful negotiating point where the relevant strategy relates to a tight asset class with limited availability of, or liquidity in, target assets. This may be a reasonable alternative to a non-compete clause or a concession in response to a request to afford a manager exclusivity with regard to a given strategy on the platform. An element of reciprocity may also be appropriate here, with the platform undertaking to obtain a minimum level of subscriptions within a designated period or to meet some other such target – for example, to match the level of subscriptions that the manager itself brings into the fund.

Other sub-funds

While the presence of a range of managers on a platform is part of its attraction from an economic and branding perspective, this may also have negative aspect and ideally, therefore, it is in manager’s best interests to have an element of control over the types of funds that may be launched alongside any proposed new sub-fund they are to be appointed to. Some key concerns in this regard might be to limit the ability of managers with competing strategies to be taken onto the same platform (especially if such managers would enjoy the same distribution channels and these are a key part of the platform’s attraction).

However, apart from competition issues, managers pursuing ethical or environmental mandates, for example, may find it embarrassing to discover that co-managers on the same platform are pursuing contrary strategies. Managers may also wish to avoid being on a platform with highly leveraged strategies because, notwithstanding that segregated liability between sub-funds is provided for under statutory legislation in jurisdictions such as Ireland, there is a danger of negative publicity if a platform sub-fund goes into insolvent liquidation.

Ultimately managers will need to be comfortable with the existing range of sub-funds on a platform, but it is in their best interest to also have rights regarding future additions. Possible rights in this regard might take the form of a right of veto regarding the appointment of future managers but consultation and notification would be appropriate at a minimum.

Board role

The general level of interaction with the management of the fund structure as a whole should also be borne in mind. At a minimum, a sub-investment manager would need to formally report annually but, given the typical standard of (at least) quarterly board meetings, more frequent interaction is likely to be expected and ideally, this will be addressed in the terms of the appointment. The potential for a representative of a sub-investment manager to obtain a seat on the board of directors of the fund or its management company could be explored in this regard. However, in most cases, this is unlikely to be an option in practice.

Liability Standard

A platform will typically require the inclusion of liability provisions in the agreement appointing the on-boarding manager, and the standard in this regard will normally be negligence, fraud or wilful misconduct. Negligence is a higher standard of case than the “gross negligence” standard to which U.S. managers are accustomed. However, where a platform features a lead investment manager, such lead manager will generally never agree to a lesser standard of liability for a sub-investment manager than the standard to which the lead manager itself is subject.

Role and discretion – rights regarding counterparties

A platform will be established with specified key service providers (e.g., the administrator, custodian or depositary) and it generally will not be possible to vary these at the behest of any sub-investment manager. However, in relation to other service providers (such as brokers and trade counterparties), there may be some flexibility, and it would be appropriate to explore whether these relationships are established at the platform level or if there is any discretion available. In some cases, there may be exclusive arrangements with brokers or counterparties – these may be companies affiliated with the platform sponsor, and the related fee arrangements (which will probably be non-negotiable) may not be the most favourable available.

Apart from the freedom to deal with the counterparties a manager chooses, the extent to which further sub-delegation or outsourcing is possible may also be relevant for some managers. For example, the ability to outsource currency hedging or other discrete aspects of portfolio management.

Marketing

Platforms often market themselves on the basis of their distribution network and access to investors. It is appropriate to obtain full details in this regard prior to joining the platform, particularly if there will be restrictions on engaging in alternative marketing or if the platform’s channels are expected to be the primary or sole distribution route. Primary advantages of both UCITS-compliant, and now AIFMD-compliant, funds are their potential for international distribution under a pan-European passport, so it is appropriate to make sure that this is being used in practice. However, funds are generally sold rather than bought, so ensuring that a fund will be available for distribution in a jurisdiction is merely a first step – details should be provided as to any marketing and sales activity to be undertaken, as well as the right of the sub-investment manager to conduct its own marketing in respect of the sub-fund to which it has been appointed, or to appoint third parties in this regard at its discretion (and the cost / fee implications of this).

Conclusion

Third-party fund platforms have proven increasingly popular in recent years due to the cost and complexity involved in new fund launches and this trend seems likely to not only continue but grow in the post AIFMD world. It is clear that there are instances where a platform will be the most appropriate solution for a manager but this will not always be the case. It is essential to undertake a thorough analysis of the benefits and potential disadvantages afforded prior to joining a platform. Managers joining platforms need to ensure that as well as facilitating cost efficient market access in the short term, the contractual terms of the arrangement safeguard their position to the greatest extent possible without compromising their medium and longer term plans.

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