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To maximize business growth by providing a range of investment solutions to clients around the globe, some AIFMs/Asset Managers choose to provide Separate (Segregated) Managed Accounts (SMAs) to clients alongside the fund manager’s suite of funds, offering the AIFM/Asset Manager’s specialized investment strategies according to the client’s preference.
Many AIFM/Asset Managers don’t realise that to provide this investment solution on a cross-border basis triggers a host of regulatory requirements which (according to the SMA structure) could be totally separate to the fund marketing rules per country.
Clients have asked us over the years: “If we want to offer SMAs to investors cross-border, isn’t it just a simple case of preparing an SMA Presentation where we present our investment capability, get the investor mandate, manage the account and everyone’s happy? Is there anything else we need to know?”
Our response: YES.
Here, we delve into the SMA regulatory issues that AIFMs/Asset Managers need to know.
What is an SMA?
Separate (Segregated) Managed Accounts are provided to investors who don’t want to invest in a commingled fund, alongside other investors. The investor may request an SMA from the AIFM/Asset Manager because they wish to invest in one type of investment strategy/approach based on their due diligence and analysis of the AIFM/Asset Manager’s investment capability.
SMA minimum investment requirements for the institutional investor (example: $50 Million) are typically much higher than the minimum investment requirement to subscribe to the AIFM/Asset Manager’s commingled fund (example: $5 Million).
So this is a big investment commitment by the investor and typically is made after the investor conducts significant research & due diligence on the AIFM/Asset Manager’s investment approach, investment process, performance track record, company, management, resources, and so on.
Types of SMA structures
Separate (Segregated) Managed Accounts are typically provided in the following forms or investment vehicles:
- A Separate Account managed by the AIFM/Asset Manager under an Investment Management Agreement (IMA) whereby the AIFM/Asset Manager has investment discretion over the client’s assets/account. Typically client assets are custodied by a third party custodian. So the investment vehicle is an account.
- A standalone fund is established for the investor (“fund of one”) managed by the AIFM/Asset Manager. So the investment vehicle is a fund.
For the purposes of this Blog, we will focus on the regulatory issues for structure #1, a Separate (Segregated) Managed Account managed under a discretionary IMA.
Are there country specific rules for providing SMAs cross-border?
Yes.
Marketing funds and/or the provision of financial services in any country constitutes regulated activity and both of these activities are subject to local country regulations. You need to investigate these rules before you start fund/financial services marketing and then comply with the rules. Read about the basics in our Blog post Cross-Border Marketing Compliance: What you Need to Know.
If you provide a “fund of one” SMA to an investor in any jurisdiction, you need to check each country’s position on whether this SMA structure constitutes “fund marketing” (subject to local fund marketing rules) or the “provision of financial services” in that country (subject to the local financial services rules).
If you provide SMAs in the form of a Separate Account managed under a discretionary IMA with the investor (structure #1 above), then you are providing “financial services” in the local jurisdiction. These rules for SMA structure #1 are completely separate to fund marketing rules and differ country by country.
Heads up: As an AIFM/Asset Manager, just when you think you have completed work investigating country fund marketing regulations, you need to turn your attention to investigate licensing issues for providing SMAs to clients. This can incur a lot of time and resources to find the answers.
What is the 3-Way Licensing Challenge to provide SMAs cross-border?
To provide SMAs (financial services) cross-border, you face a 3-way SMA Licensing Challenge, requiring investigation of the following 3 issues:
- Do we need a local license to market (promote) SMAs in that country?
- Do we need a license to manage SMAs for the investor in that country?
- Do we need a license to service the SMA client in that country (after sale client servicing)?
All 3 SMA license factors (“market-manage-service”) depend on each AIFM/Asset Manager’s bespoke fact set investigated on a country-by-country basis. Each country’s rules on the provision of financial services are different (to each other), with the exception of mostly standardised licensing regulations (e.g. MiFID-II) applicable to the provision of financial services in region EU/EEA countries with the exception of unique EU country SMA rules (i.e., the Netherlands).
When should we investigate country regulations on SMAs?
We advise clients that it makes sense to investigate financial services regulations to provide your SMA (depending on the structure) at investor DDQ stage. Why go to the trouble to complete the investor’s due diligence questionnaire (DDQ) if you don’t have the right license to provide SMAs to the investor in that jurisdiction? If you need to register for a license to provide the SMA to the investor in a certain jurisdiction, you need to know that up front too.
Doing the SMA regulatory due diligence up front helps you avoid “egg on your face” in front of the investor, who is making a big financial commitment to the AIFM/Asset Manager, who will be providing the investor with SMA services.
Who holds the 5-Key Distribution Risk “Hot Potato”?
The same 5-Key Distribution risk principles that apply for breaches of local country fund marketing regulations also apply to breaches of licensing regulations for the provision of financial services (SMAs) in any country. Read all about risk in our Blog post 5-Key Distribution Risks for Cross-Border marketing.
It is the AIFM/Asset Manager holds the 5-Key Distribution Risk Hot Potato.
If you breach financial services licensing regulations, you could get sanctioned by the regulator (Sanctions Risk), you could get sued by the investor (Litigation Risk) and/or the investor could request their SMA money back by exercising a rescission rights claim (Rescission Rights Risk) — all of which lead to Business Franchise and Reputation Risks.
In a certain Asia country, sanctions applicable for the unlawful provision of financial services such as SMAs without a license from the local Regulator are 10 Years’ Imprisonment.
Serious consequences — but ones you can avoid.
Summary: Providing Separate (Segregated) Managed Accounts as a complementary investment vehicles offering to your commingled fund suite makes a lot of commercial sense to some AIFM/Asset Managers.
Meeting the 3-Way Licensing challenge is key: Do the research up front on licensing regulations that apply to you, based on your bespoke fact set and SMA structure, BEFORE you fill out the SMA DDQ. It will save you a lot of time and potential downside risk.
Need further insight and help on assessing the risks and opportunities with your SMA offering?
With two decades of experience researching the SMA 3-Way Licensing issues in 55+ countries, we can save you time and resources. Contact us via info@gscompliance.com and visit our GSC Ltd. website for more information: www.globalsalescompliance.com.
An SMA offering is big-ticket business which requires preparation: Don’t blow it by ignoring the 3-way SMA Licensing Challenge.
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