Hedge funds’ capital-raising activities in Europe could be hindered by new rules impacting the pre-marketing process under changes to the EU’s Alternative Investment Fund Managers Directive, industry practitioners warn.
• New EU rules on pre-marketing and reverse solicitation could upend hedge funds’ capital-raising activities in the bloc
• Hedge fund managers are now drafting in additional legal and compliance expertise to address the changes, which form part of the ongoing AIFMD review
• More than half (59%) of hedge funds in Europe are concerned about the impact of the AIFMD reforms, which are expected to be ratified later this year
Hedge funds’ capital-raising activities in Europe could be hindered by new rules impacting the pre-marketing process under changes to the EU’s Alternative Investment Fund Managers Directive, industry practitioners warn.
The ongoing AIFMD II review – which includes reforms to marketing, delegation, liquidity and reporting rules – is set to be ratified by the European Council and EU parliament in the second half of the year.
Key for hedge funds and other alternative investment firms are proposals that will alter the ways in which firms can pre-market their products in the bloc, including new curbs on reverse solicitation.
“Due to the new regime on pre-marketing it can preclude relying on reverse solicitation for a period of 18 months following the start of pre-marketing, and fund managers will need to notify the relevant regulator of their pre-marketing activities, within two weeks of starting to pre-market,” says Kavita Devani, head of compliance operations at Coremont.
As a result, hedge fund managers can no longer expect to simply organise investor roadshows across EU countries. Instead, each country’s rules need to be reviewed individually.
“Managers need to really think about what countries they are targeting,” Devani says of the changes. “Before they were able to speak to many more potential investors – but it’s not so easy now.”
In response, hedge funds and other asset managers from outside the EU – including the UK – are now enlisting additional legal counsel or compliance support to help them determine which jurisdictions to enter, and how to make an initial foray into certain countries, since they can no longer rely on reverse solicitation. At the same time, certain third party service providers who offer marketing and distribution products for fund managers may also be squeezed by the new requirements, industry practitioners say.
“We have a lot more queries coming in from hedge funds,” Devani adds.
“With stricter guidance, they need legal counsel, or compliance support, to be able to make that decision on when and how to enter the marketplace. They are asking what the rules are in each particular country – is it better to register or not register? Should they pre-market or not?.”
The tweaks – which stem from a growing “regulatory discomfort” within the EU over the concept of seconding people to other entities in Europe to market a fund where a UK firm has no other marketing options available in the EU – have split the hedge fund industry in the region.
A survey of UK and European managers conducted for Hedgeweek’s Insight report – ‘Regulatory Risk: Confronting the new global hedge fund compliance challenges’ – shows 50% are ‘somewhat concerned’ by the AIFMD II plans, with a further 9% ‘very concerned’. On the flipside, 41% say they are not concerned. The report explores in depth the gathering momentum of regulatory change post-pandemic, and its potential impact on the hedge fund industry on both sides of the Atlantic.
“The pre-marketing issue has, for a number of distribution models, caused a few problems for firms pre-marketing in Europe,” says Gary Pitts, founder and managing partner of boutique compliance and governance consultant Tetractys Partners.
“Whereas in the past, you would normally spend 20% of your effort getting to 80% of your AUM, and just focusing solely on that because of limited bandwidth, I have seen some managers now who are sufficiently AUM-desperate to the extent that 80% of their efforts are going to try and capture that final 20%, with all sorts of costly regulatory contortions to try and distribute to sophisticated retail investors either in the UK or throughout Europe,” Pitts says.
“It’s an ad-hoc process, and it’s becoming quite difficult.”
Overseen by the European Securities and Markets Authority (ESMA), the pan-European watchdog, AIFMD took effect in 2013, aimed at strengthening investor protection following the Global Financial Crisis and heralding closer regulatory scrutiny of hedge funds’ activities.
Key Implication | Managers: Hedge funds are facing additional challenges when it comes to connecting with investors and raising capital in Europe as a result of proposed changes to the AIFMD’s marketing rules, which include curbs on reverse solicitation. Firms now need to think more carefully about roadshow processes and which jurisdictions to enter.
