New Rules for Pre-Marketing Funds and Reverse Solicitation
By Kam Dhillon, Gowling WLG (UK) LLP
Published: 27 September 2019
The Cross-border Distribution Directive EU/2019/1160 (CBDD) and Cross-border Distribution Regulation EU/2019/1156 (CBDR) amend the Alternative Investment Fund Managers Directive (AIFMD) and introduce new rules for the pre-marketing of alternative investment funds (AIFs) in the European Union (EU).
The new rules will impact existing practices in relation to pre-marketing activities - the key change being the introduction of a new notification requirement for pre-marketing to professional investors in the EU, which will have implications for reverse solicitation.
Objectives of the new rules
The new rules aim to harmonise regulatory and supervisory approaches to pre-marketing activities for AIFs managed by EU alternative investment fund managers (AIFMs) within the framework of AIFMD.
Currently, what does (and does not) constitute 'marketing' under AIFMD varies significantly across the EU, notwithstanding that it is defined in AIFMD as the "direct or indirect offering or placement, at the initiative of (or on behalf of) the fund manager of units or shares of an AIF it manages, to or with investors domiciled, or with a registered office, in the EU."
This matters because, pursuant to AIFMD, 'marketing' an AIF in the EU triggers certain compliance obligations. This includes a requirement to submit a prescribed form notification to the national competent authority in the EU member state in which one wishes to market. Failure to do so may result in a fine or public censure. In addition, any subscription agreements entered into as a result of unlawful marketing may be unenforceable.
In contrast, reverse solicitation - i.e. where an investment is made, at the initiative of an investor, in an AIF managed or marketed in the EU - does not trigger any notification obligations.
Nor does pre-marketing. This is good for fund managers because it means they can test a market and explore whether there is sufficient investor appetite before proceeding with a particular investment strategy and establishing an AIF, and before obtaining a marketing passport or submitting a marketing notification and incurring the associated costs.
Current rules and practice in the UK
The UK regulator, the Financial Conduct Authority (FCA), takes the view that communications relating to draft documentation do not constitute 'marketing' under AIFMD. Instead, such promotional activities are subject to compliance with the financial promotion regime under the Financial Services and Markets Act 2000 (FSMA).
'Marketing' under AIFMD is deemed to take place in the UK when units or shares in an AIF are available for purchase and final form contractual documents are provided to prospective investors. However the FCA recognises that other EU member states may take a different view (as has been the case).
Current rules and practice in the EU
There is no guidance from the European Commission or the European Securities and Markets Authority on the meaning of marketing pursuant to AIFMD, nor is there any consistency in terms of approaches relating to marketing (or reverse solicitation) in member states.
Similarly for pre-marketing, while some member states permit it, the way in which pre-marketing is defined, and the conditions attached to it, tends to vary. In other member states, there is simply no concept of pre-marketing.
The CBDD and the CBDR aim to address this divergence.
What is 'pre-marketing'?
'Pre-marketing' is defined in the CBDD as follows:
"The provision of information or communication, direct or indirect, on investment strategies or investment ideas, by an EU AIFM or on its behalf, to potential professional investors domiciled, or with a registered office, in the EU, in order to test their interest:
- in an AIF (or a compartment) which is not yet established; or
- in an AIF (or a compartment) which is established but not yet notified for marketing under articles 31 or 32 of AIFMD;
in the member state where the potential investors are domiciled or have their registered office, and which does not amount to an offer or placement to the potential investor to invest in the units or shares of that AIF (or compartment)."
Which AIFMs are in scope?
The pre-marketing rules apply to authorised EU AIFMs only. In the UK this would capture full scope UK AIFMs and small authorised UK AIFMs.
The CBDR extends the pre-marketing regime to managers of qualifying venture capital funds and qualifying social entrepreneurship funds.
Other small registered AIFMs in the UK (such as internally managed, closed-ended investment companies and external managers of certain property funds) are not in scope of the pre-marketing rules under the CBDD or the CBDR.
What about non-EU AIFMs?
The pre-marketing rules do not apply to non-EU AIFMs (such as Canadian or US fund managers) marketing their funds in the EU under the national private placement regime (NPPR).
It will be up to the national competent authority in each EU member state to determine whether to extend the pre-marketing rules to non-EU AIFMs under the NPPR.
Conditions for pre-marketing in the EU
EU AIFMs may engage in pre-marketing, provided that the information presented to potential professional investors:
- is insufficient to allow investors to commit to acquiring units or shares of a particular AIF;
- does not amount to a subscription form or similar document (whether in draft or final form); and
- does not amount to a final form constitutional document, prospectus or offering document for an established AIF.
Pre-marketing with draft documents
EU AIFMs may, as part of their pre-marketing, provide potential professional investors with a draft prospectus or draft offering documents, but the documents must not contain information sufficient to allow investors to take an investment decision.
The draft prospectus or draft offering documents must clearly state:
- the document does not constitute an offer or an invitation to subscribe to units or shares in the AIF; and
- the information presented in the documents should not be relied upon because it is incomplete and may be subject to change.
EU AIFMs must ensure their pre-marketing activities are adequately documented.
New notification requirement for pre-marketing
Within two weeks of starting to pre-market, an EU AIFM must send an informal letter or email to its home regulator with the following information:
- the member states it is (or has) engaged in pre-marketing;
- the time periods in which the pre-marketing is taking (or has taken) place;
- a description of the pre-marketing activities (including a description of the investment strategies presented); and
- a list of the AIFs and compartments of AIFs that are (or were) the subject of pre-marketing.
The home regulator will then inform the national competent authority in each member state in which pre-marketing is taking, or has taken, place.
This notification requirement is new and represents a key change for UK AIFMs, who typically undertake promotional activities under FSMA (without notifying the FCA) before they start 'marketing' under AIFMD.
What does this mean for reverse solicitation?
Currently, AIFMD does not restrict professional investors who wish to invest in AIFs on their own initiative. Confirmation from the investor that the offering or placement of units of shares of the AIF was made at its initiative is normally sufficient to demonstrate reverse solicitation. On a more practical level, it means the AIFM does not need to submit a marketing notification to the regulator.
Once the new pre-marketing rules come into force, any subscription by professional investors, within 18 months of an EU AIFM having begun pre-marketing, to units or shares of an AIF referred to in the information provided in the context of pre-marketing, or established as a result of the pre-marketing, is considered to be the result of marketing.
This means EU AIFMs will be required to submit a marketing notification to the relevant regulator following pre-marketing.
It effectively means there will be an 18 month moratorium on reverse solicitation, though it is not clear whether this restriction applies to investors or to each EU member state subject to pre-marketing. Either way, it appears as though it will become more difficult to rely on reverse solicitation.
Who can engage in pre-marketing on behalf of an EU AIFM?
The following third parties may engage in pre-marketing activities on behalf of an EU AIFM:
- an investment firm or a tied agent (in accordance with the Markets in Financial Instruments Directive II);
- a credit institution (in accordance with the Capital Requirements Directive);
- a UCITS management company (in accordance with the UCITS Directive); or
- an AIFM (in accordance with the CBDD).
When do the new rules apply?
The new pre-marketing rules are expected to apply from August 2021.
The European Parliament adopted the CBDD and CBDR on 16 April 2019, and the European Council followed shortly after in June 2019. The CBDD and CBDR was published in the Official Journal of the EU on 12 July 2019 and (subject to limited exceptions) entered into force on 1 August 2019. Member states must transpose the pre-marketing rules into national law from 2 August 2021.
Notwithstanding Brexit, the UK is likely to adopt the CBDD and the CBDR into UK financial services laws. The Financial Services (Implementation of Legislation) Bill 2017-2019 provides a mechanism for HM Treasury to implement EU financial services legislation that is currently in the pipeline for a period of two years after the UK leaves the EU, and this includes the CBDD and the CBDR.
Funds looking to raise capital from professional investors in the EU from 2021 onwards must factor these new rules into their fundraising schedule.