Reverse solicitation rule not catching out asset managers

No single asset manager appears to have yet fallen foul of the rules governing reverse solicitation under the EU’s Alternative Investment Fund Managers Directive although the risk of regulatory sanctions for breaches does still remain.

By Editorial
No single asset manager appears to have yet fallen foul of the rules governing reverse solicitation under the EU’s Alternative Investment Fund Managers Directive (AIFMD) although the risk of regulatory sanctions for breaches does still remain.

A number of non-EU fund managers have sought to bypass AIFMD compliance by not marketing to EU investors. Instead, those managers simply wait for EU investors to make inquiries about their product offering on their own volition. Put simply, it is a marketing strategy of doing nothing and hoping for the phone to ring from interested investors. While investors may willingly contact brand-name firms, they are less likely to initiate meetings with less well-known organisations. Reverse solicitation is also a highly risky approach for managers to take and one that is open to much debate.

“I have not yet heard of a manager being targeted by regulators for breaching the rules on marketing under the AIFMD. However, there is a risk that if an investor loses money in a fund, they could complain to the regulator that the manager marketed to them in contravention of the AIFMD,” said Anna Washington, associate director for asset management regulation at the Alternative Investment Management Association (AIMA), speaking at the Distributing Alternative Investment Funds Europe 2016 Conference in London.

Assessing what may or may not be acceptable under reverse solicitation has stirred a number of legal discussions. Conservative minded lawyers have suggested that supplying performance information to subscription-only databases accessible by institutional investors could be a violation of reverse solicitation. Utilising capital introduction services at prime brokers or third party marketers is also a risk.

Peter Northcott, executive director at KB Associates, said capital introductions was a grey area. “There are divergent views on capital introductions. Some prime brokers are adopting a very cautious approach and requiring investors and managers to sign documentation and disclaimers before entering cap intro conferences confirming that it is not a marketing event in any way,” he said.

At the heart of ensuring manager compliance with AIFMD’s rules on reverse solicitation is maintaining a record of communications with investors. Having an easily auditable paper trail of conversations with investors is essential if managers get scrutinised by regulators. A failure to demonstrate compliance can result in regulatory fines and punishments, and the subsequent reputational risk. Again, the likelihood of regulators taking note of managers’ marketing practices will depend on the nature of the market itself. Some jurisdictions such as Germany are likely to take a tougher, more prescriptive line than the UK or Holland, for example.

Most non-EU managers appear to recognise that national private placement regimes (NPPR) or attaining full AIFMD compliance are the best approaches to attracting EU investor flows rather than relying on reverse solicitation. “Most managers have found that while AIFMD had initial challenges, compliance has been palatable,” said Washington. However, there is uncertainty over how long NPPR will be in place. The European Securities and Markets Authority (ESMA) is assessing third countries’ equivalence with AIFMD and some of these jurisdictions could attain the pan-EU AIFMD marketing passport. This could result in NPPR being shut off as and when this occurs.

At present, Guernsey, Jersey and Switzerland have been told they meet AIFMD equivalence although the European Commission (EC) has yet to pass a Delegated Act enabling them to take advantage of the passport. Twelve other jurisdictions including the US, Hong Kong, Singapore, Cayman Islands, British Virgin Islands (BVI), Australia, Japan and the Isle of Man are all being assessed. It is believed that ESMA will deliver its verdict to the EC on these countries’ equivalence with AIFMD in June 2016.

However, this could cause some problems. Both the jurisdiction where the fund is domiciled and where the manager is located must be equivalent for a manager to obtain the passport. In other words, if the Cayman Islands was given equivalence but the US was not, a Connecticut-based manager with a Cayman Islands domiciled fund could not obtain the passport. Washington said such a scenario would reduce investor choice in Europe. However, one fund manager recently said the Panama Papers leak could make it politically complicated for ESMA to grant equivalence to offshore jurisdictions at the moment.

Furthermore, Washington added that ESMA had flagged some divergences in policy between the US and EU as being potential stumbling blocks to equivalence. ESMA has said that the US does not have remuneration requirements in line with those found in the EU, and it has also referenced the difficulties UCITS could have when accessing the US retail market. This is an odd complaint for ESMA to raise because AIFMs are meant for accredited investors as defined by the Markets in Financial Instruments Directive (MiFID) only. As such, UCITS’ ability to target US retail is a completely irrelevant issue. Cynics point out EU-US discussions over whether US central counterparty clearing houses (CCPs) meet EU equivalence under the European Market Infrastructure Regulation (EMIR) have taken years. US fund managers are likely to face similar challenges.

Should agreement be reached on third country equivalence, fund managers would have to navigate the gold-plating prevalent across EU member states. A number of UCITS managers complain that the regulations and rules vary across EU countries despite UCITS IV prohibiting member states from introducing impediments and barriers to cross-border UCITS distribution. AIFMD seems to be following a similar trajectory with countries such as France and Spain introducing additional costs and obligations for managers. Some countries have stipulated voluntary aspects of the Annex IV regulatory report be mandatory. Again, this requires managers to continually review the law in each member state where they are marketing to ensure they do not fall foul of the rules.