Impact of New EU Rules on Fund Managers
EuVECA, EuSEF and PRIIPs May Give Birth to More KIDs
Last month saw changes introduced to the European Venture Capital (EuVECA) and European Social Enterprise Fund (EuSEF) Regulations – designed to make both regimes more accessible. It will now be possible for fund managers already registered under the European Union’s Alternative Investment Fund Managers Directive (AIFMD) to register and market individual funds under EuVECA and EuSEF rules, provided they meet qualifying criteria.
Those rules include the ability to market funds to high net worth retail investors, which, in turn, could bring another set of recently introduced EU regulations into play – the Packaged Retail and Insurance-based Investment Products (PRIIPs) regulation.
The impact of new regulations always needs to be assessed as part of a broader regulatory framework. When PRIIPs came into force at the beginning of this year, many alternative investment fund managers would have been forgiven for thinking the regulation did not apply to them given that it focused on retail products. Yet the concurrent implementation of MiFID II changed the definition of a retail client. It meant local authorities were automatically classified as retail investors. This meant fund managers marketing to local authority pension or investment schemes (those which had not voluntary been opted up to professional status) would be subject to PRIIPs and therefore obliged to produce current Key Information Documents (KIDs).
The introduction of changes to the EuVECA and EuSEF regimes in March have been designed to increase uptake of the designations and there are many features of the new rules that have been welcomed by the industry. However, because EuVECA and EuSEF funds can be marketed to high net worth individuals (with minimum investment of €100,000) who would be classified as retail investors under MiFID. The funds will also become subject to PRIIPs and be subject to the regulatory overhead of having to produce Key Information Documents (KIDs).
Key Changes to EuVECA and EuSEF
EuVECA and EuSEF were intended to complement AIFMD by offering a lighter set of regulatory obligations – including, lower capital requirements, no depositary – for smaller fund managers focused on small and medium sized enterprises (SMEs) and social enterprises, respectively. However, uptake of both designations was initially somewhat underwhelming, which prompted further consultations and resulted in the recent updates to the rules. These include:
The original EuVECA regime, which came into force in 2013, was available only to those small fund managers that fell below the relevant asset under management thresholds under Art 3.2.(b) of the AIFMD (i.e. <€500m, unleveraged). This effectively made AIFMD and EuVECA mutually exclusive – a manager that was a full scope alternative investment manager authorised under the AIFMD could not subsequently adopt the EuVECA designation for relevant offerings and avail of the resultant benefits. However, the revised rules allow full scope AIFMs to register individual funds under the EuVECA umbrella.
Relaxed Criteria for EuVECA Investments
EuVECA funds need to invest at least 70% of their assets under management into qualifying investments. The rules defining a qualifying SME investment have been relaxed. Originally, the definition covered private companies with up to 250 employees but has now been expanded to those with up to 499 employees, and also now includes companies listed on SME growth markets.
Limit on Host Fees
Changes to EuVECA and EuSEF seek to strengthen passporting rights by prohibiting national competent authorities in host nations from imposing “fees and other charges on the managers for the marketing of such funds if no supervisory task has to be performed” – an often criticised practice.
Harmonization of Capital Requirements
EuVECA and EuSEF were both intended to provide less burdensome capital obligations than AIFMD: “the level of own funds should be… significantly lower and less complex than the amounts laid down in [AIFMD].” However, although the original rules allowed national competent authorities to specify what constituted sufficient levels of own funds / capital, the new rules ensure consistent interpretation by applying minimum capital requirements across all NCAs. These are defined as having at least €50,000 in initial capital, plus additional own funds to cover an eighth of fixed overheads incurred over the previous year, and an additional 0.02 cents of own funds for each Euro of assets under management exceeding €250 million.
Guaranteed Two-month Registration Turnaround
Another change introduced refers to guaranteed registration times for EuVECA funds. The new rules state that the “competent authority of the home Member State shall inform the manager… no later than two months after it has provided all the information referred to in that paragraph.” Before, the statutory timeframe was set in the UK at three months, with the end to end process often taking six months. The FCA details registration requirements via its site, although managers can significantly simplify the registration process (which includes the need to produce a regulatory compliance plan) through our managed service.
PRIIPs Bring KIDs into Play
The PRIIPs rules introduced at the beginning of 2018 apply to investment products made available to retail investors. For the most part, this makes the rules less relevant to the world of hedge funds and private equity funds, which tend to be targeted at professional investors.
However, there are notable exceptions. Leaving aside the open interpretation of ‘made available’, one such exception was brought about by the fact that MiFID II automatically classified local authorities / municipalities as retail investors. Another, results from the fact that EuVECA and EuSEF funds can be marketed to high net worth individuals, which means they are explicitly included in the list of products defined as PRIIPs.
That means any AIFM looking to take advantage of recent rule changes and register a fund under the EuVECA or EuSEF designations will also need to consider the requirement to produce KIDs. These are standalone three-page documents that contain a standardized set of information designed to help retail investors compare products more easily. KIDs include prescribed sections detailing the purpose of the KID, a comprehension alert, product description (including details of target investor type), risk/reward profile, details on guarantees, costs, early redemption, complaints procedures and any other relevant information.
Firms will need to assess whether the administrative overhead required to produce key information documents (KIDs) cancel out the benefits offered by the EuVECA and EuSEF designations before looking to register funds under those regimes. Ultimately, that decision may depend on each firm’s circumstances, such as whether they are already producing KIDs for other products and are already familiar with the requirements. Overall – and of course, the commercial imperative will win out- where investor demand is there, these regulatory challenges are readily surmountable. Whether the revised EuVECA and EuSEF regimes will now be more attractive to fund managers and utilized more than they have been before is an open question.