March 27, 2013

The European Union Alternative Investment Fund Managers Directive: Update for Non-European Private Fund Managers

For the last several years, the European Union has been working to develop a series of uniform standards for the marketing and operation of alternative investment funds ("AIFs") within the European Economic Area (the "EEA").[1] The principal document giving effect to these efforts (the "Directive") was adopted in June 2011, supplemented in December 2012 by Level 2 implementing regulations, and further supplemented in February 2013 under Guidelines published by the European Securities and Markets Authority ("ESMA" and the "ESMA Guidelines").[2]

This Client Alert provides an update to non-European private fund managers ("NE Fund Managers" or "Managers") with regard to marketing and compliance rules under the Directive that will come into effect on July 22, 2013 (the "Effective Date").[3]


The various member states of the European Union have their own laws governing the marketing and operation of AIFs within their borders.  From the perspective of NE Fund Managers, those laws most significantly concern the procedures under which fund interests may be marketed to EEA persons (ranging from legends for private placement memoranda to possible registration with regulatory agencies).

It is anticipated that these separate laws will be replaced in 2018 by a uniform set of rules adopted pursuant to the Directive that will require non-EU managers that wish to market funds into Europe to establish a place of business in the EU and obtain authorization there. During the interim period commencing on the Effective Date, the member states' separate laws generally will remain in force, but will be supplemented by a uniform set of minimum requirements under the Directive. Those minimum requirements are discussed in this Client Alert. The minimum requirements must be adopted separately by each member state, but it generally is anticipated that all or substantially all member states will have adopted the minimum requirements by the Effective Date. Failure to comply with these requirements generally would constitute a violation of law in the applicable member states and may give rise to a variety of remedies, possibly even allowing investors located in those member states to rescind their investments and demand a return of their invested capital.  The Directive generally does not preclude member states from continuing or adopting (prior to replacement in 2018) rules more stringent than the Directive's minimum requirements.

The minimum requirements discussed in this Client Alert relate only to NE Fund Managers. The Directive specifies more substantial requirements for fund managers that are located, or manage funds organized, in the EEA. Thus, for purposes of this Client Alert, NE Fund Managers include only managers that are located outside the EEA and manage funds organized exclusively under the laws of non-EEA jurisdictions.

In determining where a fund manager is located, the Directive looks to the location of its registered office.

Each AIF has only a single manager for purposes of the Directive. In general, the manager will be the entity that is responsible to investors (e.g., the "Limited Partners") for carrying on the portfolio acquisition/disposition and risk management activities of the AIF. The manager need not carry out these activities on a day-to-day basis, and may delegate day-to-day activities to an investment manager, adviser, back-office entity or similar person, so long as the manager remains ultimately responsible for the proper conduct of these activities and provided that the manager does not delegate so many of its responsibilities that it becomes merely a "letterbox entity." For example, in the context of a typical VC/PE fund organized as a limited partnership, the manager generally will be the fund's "General Partner."

Particular attention will be necessary if the Manager also has personnel based in an EEA country. Although the Manager would continue to be an NE Fund Manager (because having EEA staff will not change the Manager's registered office), establishing a bona fide branch in the EEA would require local authorization to carry on the regulated activity of acting as a manager to an AIF. While the determination would be based on all facts and circumstances, authorization generally should not be required if the EEA staff provide their services to the non-EEA head office of the NE Fund Manager, rather than to the AIF itself.

It is important to note that the Directive and implementing regulations are quite new, and the laws, rules and regulations to be adopted by member states have not yet, in many cases, been written. Thus, many important questions arising under the Directive have not yet been addressed and may remain open for the foreseeable future.


Except as described below, an NE Fund Manager will become subject to requirements under the Directive only upon marketing an AIF to a person within the EEA on or after the Effective Date. Marketing is defined in the Directive as a "direct or indirect offering or placement […] of units or shares in [a fund]." This gives rise to a number of questions as to what constitutes "marketing." In general, although definitive guidance is not yet available, it would appear that "marketing" should not include: (i) generalized, public statements (e.g., made on a website or at a meeting/conference) outside the EEA; (ii) responding, from outside the EEA, to an inquiry or solicitation received from a person within the EEA; or (iii) the issuance of capital calls in respect of existing binding capital commitments.

Among other things, this suggests that a firm which desires to market interests in a new fund solely to EEA Limited Partners in existing funds may avoid requirements under the Directive by informing those Limited Partners (via a communication outside the EEA, such as at a VC/PE fund's annual meeting held outside the EEA) that they will be eligible to participate in future funds only if they affirmatively request information regarding those funds, because information regarding those funds will not be provided by the firm absent such a request. This is only one example of "reverse solicitation" that may be effective to avoid obligations under the Directive. Any manager that wishes to use this exemption should ensure that it retains thorough records of all such communications; it is not unlikely that regulators will challenge managers in the future to demonstrate that their promotions are in accordance with the Directive regime.

So long as marketing is not undertaken with an expectation of gaining access to EEA persons, marketing to a non-EEA intermediary (e.g., a "gatekeeper") outside the EEA generally should not be considered marketing to a person within the EEA, even if the intermediary forwards information to one of its EEA clients (although the intermediary may thereby trigger obligations for itself under the Directive). However, if marketing to an intermediary does lead to investment by an EEA person, it may be difficult to rebut assertions that such an expectation must have existed. For this reason, it may be advisable to obtain written confirmation from the intermediary that it will not forward any information to an EEA person, unless it has received the NE Fund Manager's written consent.

Similar considerations apply with regard to non-EEA branches of EEA institutions. In particular, marketing to a non-EEA branch of an EEA institution generally should not be considered marketing to a person within the EEA, even if the branch forwards the offer to its head office, so long as it was not reasonably understood that the branch would do so (but, in the absence of a written agreement to the contrary, it may be difficult to rebut assertions that such an understanding must have existed).

In general, any marketing activities of a placement agent engaged by an NE Fund Manager would be attributed to such NE Fund Manager for purposes of these rules.

Fund Jurisdiction

Under the Directive, an NE Fund Manager may market an AIF to a person within the EEA only if the AIF is organized under the laws of a permitted jurisdiction. In brief, for a country to be a permitted jurisdiction, there must be a cooperation agreement in place between the regulatory authorities of such jurisdiction and the regulatory authorities of the EEA member state in which the marketing is to take place. We expect that such agreements will be in place for the major non-EEA jurisdictions in which private funds are organized (such as the United States and the Cayman Islands), but it remains to be seen whether they will be in place by the Effective Date. Currently, Switzerland is the only country to have such an agreement in place.[4]


Under the Directive, an NE Fund Manager cannot accept an AIF investment from an EEA person without first providing the information described below. Much (but not all) of this information would be contained in a typical private placement memorandum. There is no requirement that the information be contained within a private placement memorandum or any other specific document, and it should be acceptable to provide any or all of the information via a supplemental document (e.g., a "wrapper"), a due diligence package, a virtual dataroom or similar means. For those items of information that consist of actual business terms, providing the investor with a copy of the governing agreement (e.g., a limited partnership agreement) setting forth such terms generally should be sufficient. There is no requirement that the information be provided to an EEA person with whom marketing efforts have been initiated, but who does not ultimately invest.[5]

  • A description of the investment strategy and objectives of the AIF, information on where any master AIF is established and where the underlying funds are established if the AIF is a fund of funds, a description of the types of assets in which the AIF may invest, the techniques it may employ and all associated risks,[6] any applicable investment restrictions, the circumstances in which the AIF may use leverage, the types and sources of leverage permitted and the associated risks, any restrictions on the use of leverage and any collateral and asset reuse arrangements, and the maximum level of leverage which the Manager is entitled to employ on behalf of the AIF.
  • A description of the procedures by which the AIF may change its investment strategy or investment policy, or both.
  • A description of the main legal implications of the contractual relationship entered into for the purpose of investment, including information on jurisdiction, on the applicable law and on the existence or not of any legal instruments providing for the recognition and enforcement of judgments in the territory where the AIF is established.[7]
  • The identity of the Manager, the AIF's depositary/custodian, auditor, administrator and any other service providers and a description of their duties and the investors' rights.[8]
  • A description of any professional indemnity insurance arrangements taken out by the Manager.[9]
  • A description of any management functions delegated by the Manager and of any safe- keeping function delegated by the depositary, the identification of the delegate and any conflicts of interest that may arise from such delegations.
  • A description of the AIF's valuation procedure and of the pricing methodology for valuing assets.
  • A description of the AIF's liquidity risk management, including the redemption rights both in normal and in exceptional circumstances, and the existing redemption arrangements with investors.
  • A description of all fees, charges and expenses and of the maximum amounts thereof which are directly or indirectly borne by investors.[10]
  • A description of how the Manager ensures a fair treatment of investors and, whenever an investor obtains preferential treatment or the right to obtain preferential treatment, a description of that preferential treatment, the type of investors who obtain such preferential treatment and, where relevant, their legal or economic links with the AIF or the Manager.[11]
  • A copy of the AIF's most recent annual report (see below).
  • The procedures and conditions for the issue and sale of interests in the AIF.
  • The latest net asset value of the AIF or the latest market price of a unit or share of the AIF.[12]
  • Where available, the historical performance of the AIF.[13]
  • The identity of the prime broker and a description of any material arrangements of the AIF with its prime brokers and the way the conflicts of interest in relation thereto are managed and the provision in the contract with the depositary on the possibility of transfer and reuse of AIF assets, and information about any transfer of liability to the prime broker that may exist.[14]

Annual Reports

For each AIF with EEA persons as Limited Partners, the Manager must prepare an annual report within six months after the end of each fiscal year. The report must be made available to such Limited Partners upon request. If the AIF has not been marketed in the EEA after July 22, 2013, these requirements do not apply.

An annual report must be prepared in accordance with the accounting standards of the country under whose laws the AIF is organized as well as any accounting rules specified in the AIF's governing documents. It must also be audited in accordance with international auditing standards in force in the country in which the AIF has its registered office. It appears that, for this purpose, acceptable standards are not limited to IFRS and ISA (and may, therefore, include United States GAAP and generally accepted auditing standards).

Each annual report must include the following:

  • A balance-sheet or a statement of assets and liabilities.
  • An income and expenditure account for the fiscal year.
  • A report on the activities of the fiscal year.
  • A description of any material changes, during the fiscal year, to the information described above in "Disclosure."
  • A statement of the total amount of remuneration for the fiscal year, split into fixed and variable remuneration, paid by the Manager to its staff, and number of beneficiaries, and, where applicable, the amount of carried interest paid by the AIF.[15]
  • The aggregate amount of remuneration broken down by senior management and members of staff of the Manager whose actions have a material impact on the risk profile of the AIF.[16]

Reports to Regulators

An NE Fund Manager that markets an AIF within a specific EEA member state must report certain information to the competent authorities of such member state. This requirement raises a number of questions, such as (i) how to proceed when an act of "marketing" has occurred within a particular member state, but no investment results, and (ii) when the reporting obligation ends (in the case where no investment results, as well as the case in which an investment has been made, but marketing efforts have ceased).[17]

The information to be reported includes:

  • The percentage of the AIF's assets which are subject to special arrangements arising from their illiquid nature.
  • Any new arrangements for managing the liquidity of the AIF.
  • The current risk profile of the AIF and the risk management systems employed by the Manager to manage the market risk, liquidity risk, counterparty risk and other risks, including operational risk.
  • Information on the main categories of assets in which the AIF invested.
  • The results of stress tests performed by the manager relating to liquidity and risk management.[18]
  • Information concerning the Manager's policy on the use of leverage, if the Manager uses leverage on a "substantial basis." This includes information about the overall level of leverage, a breakdown between leverage arising from borrowings and leverage from derivatives and the extent to which the AIF's assets have been received (i.e., lent). For these purposes, leverage means any method by which the Manager increases the exposure of an AIF. It would not include, therefore, borrowings to bridge capital calls.

Presumably, the competent authorities of member states will, over time, issue specific rules as to when and how such information shall be reported. In particular, the Directive does not require any form of pre-marketing approval from, or reporting to, the competent authorities of member states. However, we are aware of at least two member states (the United Kingdom and Germany) in which a requirement of pre-marketing approval is under active consideration.

It currently is anticipated that information provided to competent authorities pursuant to this requirement will be treated as confidential and not publicly disclosed. However, under the ESMA Guidelines, a Manager may be required to publicly disclose a high-level description of its remuneration policies.

Professional vs. Retail Investors

Under the Directive, marketing AIFs to non-professional investors (e.g., individuals as opposed to institutions) generally is prohibited. However, any member state may authorize marketing within its territory to non-professional investors, subject to such additional regulation or requirements as the member state may adopt.

Additional Requirements for Investments in EEA Large Private Companies

The Directive imposes additional requirements upon Managers of AIFs which invest in non-publicly-traded (i.e., non-listed) companies incorporated in the EEA that are neither real estate SPVs nor small/medium-sized enterprises ("Applicable Companies"). For this purpose, a small/medium-sized enterprise is an enterprise which employs fewer than 250 persons and which has an annual turnover not exceeding €50 million and/or an annual balance sheet total not exceeding €43 million. If the AIF has not been marketed in the EEA after July 22, 2013, these additional requirements do not apply.

Notification. The Manager must notify the relevant regulatory authorities when its AIFs singly or jointly acquire more than 10% of the voting rights in an Applicable Company.[19] There are additional notification bands of 20%, 30%, 50% and 75%.

Where the Manager's AIFs singly or jointly have control (i.e., more than 50% of the voting rights) of an Applicable Company, the Manager must inform the company itself and any other shareholders whose names and addresses are available to the Manager. The Manager must also disclose to such persons certain information regarding the Manager's policy on conflicts of interests and various other matters relating to the company's employees and the Manager's future plans regarding the company. Finally, the Manager must use its best efforts to ensure that such information is disseminated to the company's employees or their representatives.

Asset Stripping. AIFs investing in Applicable Companies will also face curbs on "asset stripping."  In particular, for two years following acquisition of control of an Applicable Company, the Manager will be obliged to use its best efforts to prevent distributions, capital reductions, share redemptions and/or the acquisition of its own shares by the company which would breach net asset or profit tests prescribed by the Directive.

Although the Directive is not entirely clear on this point, it appears likely that the determination of whether a company is an Applicable Company must be made only on the date an AIF makes an investment in the company. In particular, it appears that the asset stripping rules would not apply with respect to an investment in a non-Applicable Company merely because the company becomes more successful and subsequently qualifies as an Applicable Company.[20]

Transition Rules

The Directive contains a highly ambiguous transition rule that may provide NE Fund Managers with up to a one-year grace period before they are obligated to comply with the substantive rules described above. We are hopeful that this ambiguity will be resolved in the near future.


The Directive has important implications for managers that will market private funds, make investments or conduct operations in the EEA on or after the Effective Date. While important questions remain open, and many enabling laws/regulations have yet to be adopted, fund managers who plan to engage in such activities should begin preparing to comply with the Directive's requirements.


[1] This generally includes all of Europe with the exception of Switzerland.

[2] Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.  Commission Delegated Regulation (EU) of 19.12.2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision.  Final report, Guidelines on sound remuneration policies under the AIFMD, 11 February 2013/ESMA/2013/201.

[3]  Substantial uncertainty exists as to whether NE Fund Managers will actually be required to comply with these rules on the Effective Date or whether a transition period may apply.  See "Transition Rules," below.

[4]  Additionally, any country under whose laws the AIF or Manager is organized must not be listed as a Non-Cooperative Country/Territory by the Financial Action Task Force.

[5]  As will be quickly apparent, many of the items described below are more applicable to hedge funds than VC/PE funds.  A frequent criticism of the Directive is that it often fails to distinguish among different types of AIFs.

[6]  While the Directive does not explain the scope of "all associated risks," it seems likely that the Directive does not require more detailed disclosure than is customarily associated with a well-prepared VC/PE fund private placement memorandum and, in particular, does not require disclosure at the level associated with a public offering of securities.

[7]  While the Directive does not explain the meaning of this requirement, it seems likely that this requirement may be satisfied through a description of the key legal consequences (e.g., limited vs. unlimited liability) of an investor's execution of a Fund's subscription and governing agreements.  In particular, it seems unlikely that this requirement would mandate a detailed explanation of all the material business/management/economic terms of such agreements.

[8] While NE Fund Managers that are registered under the United States Investment Advisers Act or a similar law (“Other Registered Advisers”) are required to engage a qualified custodian to hold portfolio securities and similar assets, NE Fund Managers that are exempt from such registration (e.g., firms that manage exclusively venture capital funds) are not required to utilize such services.  It does not appear that the Directive, by itself, imposes any requirement that an NE Fund Manager utilize depositary or custodial services.

[9]  The Directive is not clear on the scope of this requirement with regard to NE Fund Managers.  It seems plausible that an NE Fund Manager will be required to disclose insurance that may be available to satisfy claims against the Manager in connection with operation of the applicable Fund, but that interpretation is mere conjecture at this point.

[10] Although not specifically addressed by the Directive, it appears that detailed information regarding fees, charges and expenses may be limited to those that are clearly understood and negotiated at the time the applicable Fund is marketed (e.g., fees to the Manager and its affiliates, as well as pre-negotiated fees of any administrator, depositary or custodian.  With respect to other fees, charges and expenses, it often will be possible to provide only a broad description of their nature and potential magnitude. 

[11] Although not clearly specified in the Directive, this requirement appears to address side letters of the type often issued in connection with VC/PE fundraising and occasionally used by hedge funds.  While the matter is not free from doubt, it seems unlikely that the Directive would require advance disclosure to investors participating in a particular closing of the specific side letters that are executed only as part of such closing (although post-closing disclosure may be required).

[12] In general, the Directive contemplates that assets should be valued by a person who is independent of the individuals managing the assets.  Although not clearly specified in the Directive, it appears reasonable to anticipate that this requirement would be deemed satisfied if a valuation performed by an NE Fund Manager were subject to audit under generally accepted auditing standards.

[13] Although not clearly specified in the Directive, this requirement appears to address basic financial performance of a type that could be provided via a single set of cumulative financial metrics (e.g., net profit, IRR, multiple) based on the entire term of the AIF. The Directive does not specify whether such metrics must be calculated on a gross, net, realized, unrealized or other basis, so any basis would seem acceptable so long as the calculation method is clearly explained in the disclosure document, although Other Registered Advisers may be subject to additional requirements in other jurisdictions.

[14] Of course, the typical VC/PE fund does not employ a prime broker and the Directive does not appear to require that a prime broker be employed.

[15] In general: (i) the statement must include remuneration paid in respect of the AIF by delegates of the Manager, such as an affiliated back-office entity; and (ii) remuneration does not include dividends or other types of profit distributions made to the owners of the Manager in respect of such ownership, unless such dividends or distributions result in circumvention of these disclosure requirements.

[16] See footnote 15.

[17] The Directive imposes a reporting requirement upon an AIF manager "for each of the EU AIFs it manages and for each of the AIFs it markets in the Union."  A strict reading of this text suggests that, for a non-EU AIF, the reporting obligation may terminate upon the cessation of marketing activities provided no person has invested from that jurisdiction.

[18] Details regarding the specifications of these stress tests are set forth in point (b) of Article 15(3) and the second subparagraph of Article 16(1) of the Directive.

[19] It is unclear whether the relevant regulatory authorities are those of the country in which the target is located or those of the country/countries in which the AIF has been marketed.

[20] If control were acquired before a company became an Applicable Company, but a follow-on investment were made after the company had become an Applicable Company, it appears that the two-year period under the asset stripping rules would commence on the date control was first acquired (even though the asset stripping rules would not actually apply until the date of the follow-on investment).