Europe's secondary consideration

The UK seems to have circumvented a potential AIFM headache for secondaries players – but the issue hasn’t gone away in other European countries

Of the many issues that seem to be cropping up as the European Union’s member states start to transpose the Alternative Investment Fund Managers directive into national law, one in particular has been causing alarm for the UK secondaries market lately. 

Towards the end of the legislative process (in 2011), a line was suddenly introduced to the AIFM directive (as part of Article 6(8)) that prohibited ‘investment firms’ from marketing a fund to investors unless the manager of that fund had obtained the necessary marketing approval from its regulator.

According to Simon Currie, a partner at law firm Covington & Burling, the likely intention of this clause was to try and prevent managers from side-stepping the directive by using a third-party to market their fund, thus obviating the need for them to go through the approval process. ‘Marketing’ as defined in the directive focuses very clearly on primary fundraising and placement; indeed, the definitions have been modified to clarify this point. So Currie believes the legislators also had primary fundraising in mind when they added this last-minute modification.

Unfortunately, it was drafted in such a way – and this was also true of the UK Treasury’s original interpretation – that its scope would actually have been far wider. Investment firms would not have been able to offer any fund interest to EU investors unless the manager of that fund had the necessary approvals (for EU managers) or were complying with various requirements of the directive (for non-EU managers). And since ‘investment firms’ in this context includes intermediaries selling interests on behalf of LPs, this would clearly have had a big impact on the secondaries market.

Perhaps the most significant difficulty would have been in relation to interests in old funds now closed to investors, where the GP doesn’t have the relevant approvals and has no incentive to seek them. It seems likely that funds like this will represent a substantial part of secondary market activity in the next few years – but as the law stood, an intermediary would not have been allowed to market these interests to EU investors. 

As Currie puts it: “It would deny established European secondaries buyers access to dealflow, and it would leave sellers with a restricted universe of potential buyers.”

First, the good news. After a concerted lobbying effort, spearheaded by Currie on behalf of secondaries specialists and intermediaries, the UK Treasury recently published new guidelines that effectively resolve this problem entirely – so the restrictions will only apply to those marketing a fund on behalf of the fund manager (as it was arguably intended to do in the first place).

The bad news is that all the other European governments are still in the process of transposing the AIFM directive onto their statute books – and in most cases, they’re doing it largely verbatim. So it seems very likely that the same issue will arise elsewhere. Sources suggest that the German regulator is looking at the issue, but in most cases, there’s no sign of any such clarification.

The trouble, says Currie, is that there are so many other issues surrounding AIFM interpretation that a niche area like this can get overlooked. “It’s so specific to secondaries that it hasn’t really featured on the radar of the associations.”

The hope, of course, is that other regulators take their lead from the UK. Otherwise it could become another example of the unforeseen and unintended consequences of badly drafted legislation.