Product characterisation, so the author of this article argues, is vital in a money-raising campaign for investment funds in foreign countries, given the mix of rules that can apply.
Here is an article from a regular contributor to this
news service – Cathy Brand, CEO of Sales Road Maps
Online Ltd.®. SRMO provides analysis on a range of topics
confronting fund management businesses, including those in the
alternative investments space, when marketing their wares around
the world. This is useful guidance also for wealth managers,
private banks and advisors who want to understand compliance
requirements worldwide.
The author writes here: “In this article, we explore why
product characterisation is so fundamental to fundraising
(legally) in a foreign country. Your views on how your product is
“characterised’ in your home jurisdiction are not
necessarily applicable in foreign countries. Investment product
characterisation is a key factor in your sales compliance
platform in order to mitigate your five key distribution risks
when fundraising overseas.”
The editors are pleased to share these views; the usual
disclaimers apply around views of outside contributors. Please
email tom.burroughes@wealthbriefing.com
if you wish to do so.
One of the most confusing and complex areas of cross-border
fundraising for alternative investment fund managers (AIFMs
)/asset managers is the issue of the manager’s product structure
and how this structure is “characterised” by local regulators (or
National Competent Authorities, “NCAs”) on a country-specific
basis for promotion to investors.
Over the years we have observed that many investment managers are
unaware that investment product structure and its
classification are even a relevant consideration for
fundraising overseas. To borrow a quote from Donald Rumsfeld,
“there are known unknowns” and this is a good example.
“Investment products” for the purposes of this article could
refer to a wide range of investment vehicle offerings including
collective investment vehicles structured as open or closed end
funds, limited partnerships, exchange traded funds (ETFs),
corporate form funds, trusts, structured products, offshore
special purpose vehicle (SPV) issued securities, “fund of one”
Segregated (Separate) Managed Account and more.
The compliance analysis is a two-track process for fundraising
cross-border – meaning that a business needs to investigate
and comply with:
1. Each country’s marketing regulations
In order to know which regulatory regime applies for the
marketing of your investment product in each country, you need to
confirm how your product is classified by the regulator in each
jurisdiction.
2. Each country’s licensing
regulations
Is your investment product characterised by the local NCA as an
Alternative Investment Fund (AIF)? An Undertaking for Collective
Investment in Securities (UCITS Fund)? A security? Or any other
local nomenclature (mutual fund, collective investment scheme,
etc.)? NCAs also consider the types of clients you intend to
target in their jurisdiction.
What do regulators expect from us while fundraising in
their jurisdiction?
1: There are country-specific rules governing your marketing
activities.
Marketing investment products cross-border into overseas
jurisdictions constitutes a regulated activity. This means that
marketers and financial service providers must comply with the
local jurisdiction’s rules on the promotion of the investment
products, including solicitation to exempt categories of
investors (non-retail clients) and licensing requirements.
2: Investment product characterisation: Confirm under
which regulatory regime you are offering your product in our
jurisdiction.
This analysis is critical and often confused by AIFMs/asset
managers’ preconceived notions of how the product is
classified in their home jurisdiction. Over the years we
have observed the trend by regulators to use a “substance-based
analysis” to characterise investment products for offer in their
jurisdiction (“substance over form”).
Investment product characterisation from the local regulator’s
perspective is all about substance.
By way of example, you may think your offshore SPV issued
security (note) is characterised as a “security” offering subject
to securities offering laws. But the local NCA may “look through”
to the substance of its investment characteristics and confirm
that the product is characterised as a collective investment
vehicle (fund) subject to that country’s fund marketing
regulations.
Investment product characterisation: Isn’t there a
standardised “one-size fits all” category across all countries?
No. Let’s look at the Alternative Investment Fund
Directive (AIFMD) by way of example.
Under AIFMD, ESMA defines an alternative investment fund or “AIF”
as: “any collective investment undertaking, including investment
compartments thereof, which raises capital from a number of
investors with a view to investing it in accordance with a
defined investment policy for the benefit of those investors and
which does not require authorisation pursuant to the UCITS
Directive.”
AIFMD was implemented in the EU as a European directive;
however, each EU country was required to adopt AIFMD and
additionally could “top up” the directive with “gold plating
provisions,” or other requirements specific to their
country.
In relation to each country’s conclusions on whether a fund is
characterised as an “AIF” under their local rules (or not), there
have been attempts to harmonise the AIF definition across the EU;
however, the AIF definition may vary from one country to the
next, depending on how AIFMD has been implemented locally and the
NCA’s guidance on the AIF definition in their
jurisdiction.
This means that it is possible for an investment product to be
classified as an AIF in one country – and at the same time
fall outside the AIF definition in another country.
Can we assume that our product’s characterisation in our
home jurisdiction is valid in foreign countries?
Not necessarily.
This is a classic example of “Thinking locally while acting
globally.”
To demonstrate this concept, here is a recent example of comments
we heard from a US investment manager: “My long only equity fund
(no derivatives, no leverage) is (characterised as) a “private
fund” in the US and is marketed to “Accredited Investors”
including family offices under private placement exemptions
available in the US for private funds. Naturally, my fund will be
characterised as an “AIF” when we fundraise in region EU and it
will be acceptable for us to market our fund to HNW individuals
and family offices in the EU and in all other jurisdictions
outside the US under available exemptions everywhere (applying US
regulatory treatment on an extraterritorial basis).”
To which we replied: “Please consult your fund’s legal counsel
that’s preparing your fund offering documentation and have
counsel confirm characterisation of your fund in all countries in
which it is marketed outside the US so that you can know which
regulatory regime applies per country for the marketing of your
fund. You cannot assume equal regulatory treatment in the US and
outside the US.”
Fund manager reaction: (baffled and confused look,
completely flummoxed)
This “wearing your local hat while acting globally” is always
fraught with potential distribution risk.
Investment product characterisation is a
country-by-country check
What you think about your product description in your home
country should be confirmed by your legal counsel before you
start fundraising overseas.
More importantly, your counsel who is preparing the product’s
offering documentation should confirm the characterisation of
your investment vehicle and the regulatory regime that will be
used in every country in which the product is marketed.
So it is a country-by-country check and “product clearance”
process, which must be reflected in your product’s offering
documentation.
What happens if the product is offered in a jurisdiction
using the wrong regulatory regime?
This could be a potential breach of the country’s marketing
regulations.
If you breach laws in foreign countries for the marketing of your
investment product under the wrong regime, you could be subject
to the five key distribution risks: sanctions by the regulator,
lawsuits from investors, rescission rights claims from investors,
potential loss of your business franchise, and damage to your
reputation.
Why would you want to trigger any of these distribution risks?
Are regulators serious about enforcing their country’s
marketing regulations?
Many regulators mean business when you breach their country’s
regulatory regimes: A bellwether indicator of how serious the NCA
is about sanctions enforcement is to investigate what sanctions
are on the books for breaches of their country’s marketing
regulations and/or the level of fines a regulator will impose for
“bad actor” activity. It is also helpful to review actual
sanctions enforcement activity in practice to gauge how serious
the regulator is on enforcement. Since you are conducting a
regulated activity in each jurisdiction, you have to prove at any
time that you comply with each country’s rules on promotion of
investment vehicles.
Summary
Regulators expect you to comply with their regulations on
marketing your investment product in their country. Compliance
with the marketing regulations means that you need to know what
regulations apply and how the local regulator characterises your
product (and its structure) under their local rules.
Product characterisation is key to your overseas fundraising
campaign. If you don’t know how your product is described in
local jurisdictions, how can you know what regulations apply to
your product offering? Further, how can you comply with unknown
regulations?
Ask your lawyers to complete the characterisation work, then you
will be clear on the rules to follow.