Challenges for the cross-border distribution of private funds in 2022 | Skadden, Arps, Slate, Meagher & Flom LLP
On January 12, 2022, Skadden partners Greg Norman and Anna Rips hosted the webinar “Challenges for Cross-Border Distribution of Private Funds in 2022”, which looked at recent changes to the rules and regimes governing the marketing of private funds private in the United States and Europe. As levels of private capital fundraising remain high and fundraising increasingly becomes a cross-border business, it is important that fund sponsors are able to navigate these new and changing regulations.
Below are the key points discussed by Mr. Norman and Ms. Rips during the webinar.
A recording of the event is available here.
Evolution of European marketing rules
Much of the European Union’s Cross-Border Distribution Directive (CBDD) and Cross-Border Distribution Regulation (CBDR) came into force on October 2, 2021. The legislation is primarily aimed at removing regulatory barriers to cross-border distribution funds within the EU, making it easier and cheaper to do so.
The CBDD, for example, introduces a clear definition of ‘pre-marketing’, thus harmonizing the dividing line between ‘marketing’ activities, which trigger the full registration requirements of the Investment Fund Managers Directive. alternative investment (AIFMD) and “pre-marketing” activities, which are not. EU member states had taken different approaches to this divide, with associated costs for alternative investment fund managers (AIFMs) seeking to avoid triggering registration requirements when approaching potential investors. throughout the EU. This advantage is further reinforced by the broad definition of pre-marketing introduced by the CBDD. Provided that the Marketing Information does not constitute subscription or final constitutional offer materials, AIF Managers are not required to register for full marketing. Instead, AIF managers can register for pre-marketing with an informal letter to the relevant national regulators, without any direct regulatory obligations arising from this registration. This should allow AIFMs to carry out market tests before deciding whether or not to launch an AIFMD-compliant fund.
However, the CBDD only applies to EU AIFMs, which means that diverging approaches may still be taken by EU member states towards non-EU AIFMs. While some Member States have applied the pre-marketing regime to both EU and non-EU hedge fund managers, others have effectively prohibited non-EU managers from carrying out pre-marketing activities. In these Member States, non-EU AIFMS must now register their fund under the national private placement regime before providing information about the fund to potential investors. Therefore, the implementation of the CBDD has actually made it more difficult for investors in some EU member states to access global private funds.
The CBDR, on the other hand, harmonizes the rules on marketing communications within the EU. For example, AIF managers must ensure that all marketing communications aimed at EU investors are identified as such and provide equally prominent descriptions of the potential risks and rewards of the investment. As with the CBDD, the CBDR does not clearly apply to non-EU AIFMs. However, given the relatively light requirements and fairly close alignment with the rules of jurisdictions such as the US and the UK, it is likely that most managers seeking to market private funds in the EU will seek to comply with CBDR rules. The CBDR’s introduction of clear rules that broadly align with the standards imposed in other major fundraising jurisdictions will be helpful for managers preparing communications for a wide range of potential investors.
Finally, it should be noted that the CBDD and CBDR were adopted before Brexit (although their implementation date came after the UK’s exit from the EU) and the rules were not automatically transposed into UK law. To date, there is no indication that the UK government plans to introduce equivalent rules.
Evolution of marketing rules in the United States
Under the US Securities Act of 1933 (Securities Act or Act), an issuer must record sales of securities. Section 4(a)(2) of the Act provides an exemption from such registration for “transactions of an issuer not involving a public offering”, unless an exemption is available. “Public offering” is not defined in law, so most funds rely on exemption rule 506 (also known as rule D), which establishes the rules and procedures for satisfy the registration exemption of Section 4(a)(2). Other requirements relevant to marketing under the Securities Act include the Rule 506(b) requirement to offer securities only to recipients with whom the issuer has a substantial pre-existing relationship. This requirement does not apply to offers under Rule 506(c). However, most funds continue to rely on Rule 506(b).
The United States Securities and Exchange Commission (SEC) has adopted a new rule 206(4)-1, better known as the “marketing rule”, which came into effect in May 2021, with a transition period ending November 2022, whereby compliance with new rules will be required for investment advisers required to be registered under the United States Advisers Act of 1940 (Advisers Act). The new rules codify the approach to marketing communications for investment advisers in the United States, clarifying four key areas. First, the new marketing rules define and explain what constitutes advertising. Second, the new rules establish a standard of disclosure consistent with the Securities Act standard, prohibiting advisers from misrepresenting a material fact or withholding any material fact necessary to make a statement, given of the circumstances in which such statement was made not to be misleading. Third, the rules codify certain standards for the presentation of performance data, requiring advisers who include their performance results in their advertisements to present the data in a fair and balanced manner and to include net performance information whenever the raw performance is presented. Finally, a number of restrictions have been codified in the Marketing Rules regarding the provision of testimonials and endorsements. This regulatory development has gone a long way to clarifying the approach US investment advisers should take to marketing.
In December 2019, the European Union’s Sustainable Finance Disclosure Regulation (SFDR) entered into force, with certain operational provisions taking effect in March 2021. The SFDR effectively amends the AIFMD to introduce new disclosure requirements environmental, social and governance for managers and funds within the scope of this legislation.
The application of SFDR to managers of non-EU AIFs remains somewhat unclear. SFDR rules fall into two broad categories: product-level and entity-level. When SFDR was first introduced, managers of non-EU AIFs approached the rules in the same way as AIFMD, where the obligations generally apply only to the marketed product. The promoter of non-Community funds is not itself obliged to comply with the rules. However, when the European Commission was asked to clarify how the SFDR should apply to managers of non-EU AIFs, the response was still somewhat ambiguous, saying that all rules should apply. apply, in particular the requirements at the product level (that is to say, which people were already postulating). As a result, market practice still seems to have reached a plateau on this issue.
Product-level disclosure obligations require fund managers to make pre-investment disclosures to potential investors and provide ongoing reporting to actual investors. The form of some of these reports and disclosures is intended to be specified by regulatory technical standards. Although the SFDR is in force, the regulatory technical standards remain in draft form and are not expected to be finalized until the middle of this year at the earliest. Fund sponsors should therefore do their best to comply without all the necessary details.
The SFDR represents a step towards the disclosure of increasingly regulated and assessed ESG factors in marketing materials. Although there are no specific ESG rules in the United States regarding the marketing of investment funds, when announcing its review priorities in early 2021, the SEC said it was putting greater emphasis on ESG and climate risks. In a risk alert issued in April 2021, the SEC outlined the Review Division’s ESG Investing Review, which focused on three areas of staff review with respect to ESG issues: portfolio management’s consistency with the statements made with respect to portfolio management in the applicable disclosure and any relevant marketing materials; performance advertising and marketing, including all reports that investment advisers make to sponsors of ESG executives and statements made in marketing materials; and compliance programs related to investment practices and ESG disclosures. This, combined with the SEC’s request for comment on the regulation of public disclosure of changes, is a strong indicator that ESG and/or climate change regulation needs to come from the SEC.