Opportunities and Challenges for U.S. Managers Accessing Capital in Europe: Why Europe?
As a source of investment capital, Europe is a key market for hedge funds. It is estimated that total assets under management (“AUM”) in Europe increased by approximately 15% in 2014 to reach an all-time high of €19 trillion, while total assets of the continent’s asset management industry grew 74% between end 2008 and end 2014i.
In light of the evolving European regulatory environment since the financial crisis, the supply-demand characteristics of the distribution landscape have shifted dramatically, and the result has been a dearth of high-quality U.S.-located products for EU investors. European investors are sophisticated and given current circumstances, are keen on exploring new opportunities. For those U.S. managers with viable strategies, opportunity knocks.
ROUTES TO MARKET
Interested parties have a number of different routes to market, from fully registered approaches [either Undertakings for Collective Investment in Transferable Securities (“UCITS”) or Alternative Investment Fund (“AIF”)] to national private placement regimes (“NPPR”) and reverse solicitation.
The UCITS directive, for instance, provides managers with a “passport” to market open-ended funds to retail customers throughout the EU. Though mainly limited to traditional approaches, funds that employ strategies such as long-short or qualifying collective investment schemes that meet UCITS guidelines regarding diversification, leverage and risk management may still be eligible.
For non-traditional firms, there’s the AIF option, which, under the Alternative Investment Fund Managers Directive (“AIFMD”), requires that alternative managers in Europe maintain robust operational transparency on behalf of investors and regulators. This includes frequent and detailed reporting on investment practices, executive-compensation disclosures, and other critical data. As the application of AIFMD can differ from one EU country to the next, firms that operate in multiple jurisdictions will need to be aware of specific rules within each of the participating member countries.
DEVELOPING A SUCCESSFUL DISTRIBUTION STRATEGY
So what is the most appropriate route to properly access this thriving marketplace? The simple answer is there is no simple answer, as the rules vary depending on whether an investment manager has a UCITS registered for local sale, a non-locally registered UCITS, a European AIF or a non-European Economic Areas (“EEA”) AIF.
Option one involves registering as a UCITS established in the EEA (consisting of the EU plus Norway, Iceland, Switzerland and Liechtenstein) and the fund is then freely available to any EEA investor when registered locally. A UCITS offers a number of attractive marketing opportunities, including the ability to distribute across additional markets such as Hong Kong, Singapore, Taiwan, Chile and other regions. There are some notable challenges with these vehicles, however, including restrictions on certain types of investment strategies, as well as the need to offer investors daily (or at least bi-weekly) liquidity.
If the UCITS restrictions cannot be achieved, then generally speaking most European AIFs are passport-eligible (exceptions being investment managers with AUM under €100m or where a fund has 85% plus of its assets invested in one or more non-EEA funds).
In addition, AIFs can often utilize non-principal private residences (“NPPR”) exemptions. Subject to the NPPRs in place in each EU member state, private placement may be available to U.S. Managers marketing AIFs, whether EU or non-EU AIFs.
U.S. managers may be able to continue to make use of NPPRs until at least 2018, subject to a number of mandatory conditions which will apply over and above the private placement rules operating from jurisdiction to jurisdiction. Unless and until the AIFMD passport is extended to third countries including the US, NPPRs will be the sole regime available to non-EU AIFs and non-EU managers wishing to market in the EU.
Under certain circumstances reverse solicitation — a.k.a. “passive marketing” (i.e., where the investor contacts the manager) — may also be used as a gateway to the EU; however, it is a method of last resort and therefore should not be viewed in the same light as deliberate use of a passport or private placement exception. A non-solicited approach does not involve marketing — that is, investors access the fund manager, rather than the other way around. Managers that go this route should have air-tight compliance measures along with a clear and verifiable paper trail.
THE RIGHT ROUTE
Choosing between UCITS or AIF often depends on a fund’s liquidity characteristics, as well as the type of investor the fund wishes to target.
When funds are entering a ‘friendly’ jurisdiction such as the UK, for instance, using private placement is a relatively straightforward process and may suffice at least during the initial marketing phase. Almost half of European hedge fund investors reside in the UK, which is yet another positive for foreign interests since from a regulatory perspective the UK is by far the most accessible territory within the region. Obviously any distribution strategy targeting the UK will need to consider the implications of the country’s recent vote to leave the EU – the implications of ‘Brexit’ are currently unclear and are likely to remain so in the short-term.
While a little more complex than the UK, Switzerland is also an attractive target with a relatively straightforward and inexpensive approval process.
As additional jurisdictions are targeted, however, it may become more efficient for managers to fully register the fund. For example certain countries (Germany, France, Italy and Spain included) have only a limited appetite for funds outside the UCITS format.
While there are certainly challenges in accessing European investors, for those U.S. managers with the right product it may be a challenge worth consideration given the size of the market opportunity.
Asset Management Intelligence - Q3 2016