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One of the most confusing and complex areas of cross-border fundraising for AIFMs/Asset Managers is the issue of the manager’s product structure and how this structure is “characterized” by local Regulators (or National Competent Authorities, “NCAs”) on a country-specific basis for promotion to investors. 

“Investment products” for the purposes of this blog could refer to a wide range of investment vehicle offerings including collective investment vehicles structured as open or closed end funds, limited partnerships, exchange traded funds (ETFs), corporate form funds, trusts, structured products, offshore special purpose vehicle (SPV) issued securities, “fund of one” Segregated (Separate) Managed Account and more. 

 The compliance analysis is a 2-track process for fundraising cross-border – meaning you need to investigate and comply with: 

1. Each country’s marketing regulations: to know which regulatory regime apples for the marketing of your investment product in each country, you need to confirm how your product is characterized by the regulator in each jurisdiction.
2. Each country’s licensing regulations

Is your investment product characterized by the local NCA as an Alternative Investment Fund (AIF)? An Undertaking for Collective Investment in Securities (UCITS Fund)? A Security? Or any other local nomenclature (mutual fund, collective investment scheme, etc.)? NCAs also consider the types of clients you intend to target in their jurisdiction.   

In this Blog, we explore why product characterization is so fundamental to fundraising (legally) in a foreign country. Your views on how your product is “characterized” in your home jurisdiction are not necessarily applicable in foreign countries. Investment product characterization is a key factor in your sales compliance platform in order to mitigate your 5-key distribution risk when fundraising overseas.

Here is the guidance we give clients:

What do Regulators expect from us while fundraising in their jurisdiction?

#1:  There are country-specific rules governing your marketing activities. 

Marketing investment products cross-border into overseas jurisdictions constitutes a regulated activity. This means that marketers and financial service providers must comply with the local jurisdiction’s rules on the promotion of the investment products, including solicitation to exempt categories of investors (non-retail clients) and licensing requirements. Read our Blog Cross-Border Marketing Compliance: What You Need To Know

#2: Investment Product Characterization: Confirm under which regulatory regime you are offering your product in our jurisdiction. 

This analysis is critical and often confused by AIFMs/Asset managers’ preconceived notions of how the product is characterized in their home jurisdiction. Over the years we have observed the trend by Regulators to use a “substance-based analysis” to characterize investment products for offer in their jurisdiction (“substance over form”).

Investment product characterization from the local Regulator’s perspective is all about SUBSTANCE. By way of example, you may think your offshore SPV issued security (note) is characterized as a “security” offering subject to securities offering laws. But the local NCA may “look through” to the substance of its investment characteristics and confirm the product is characterized as a collective investment vehicle (fund) subject to that country’s fund marketing regulations. 

Read more about form vs substance in our Blog “Marketing Compliance Form vs. Substance: What’s Most Important to Regulators?”

Investment product characterization: Isn’t there a standardized “one-size fits all” category across all  countries?

No. Let’s look at the Alternative Investment Fund Directive (AIFMD) by way of example.   

Under AIFMD, ESMA defines an alternative investment fund or “AIF” as:

“any collective investment undertaking, including investment compartments thereof, which raises capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors and which does not require authorisation pursuant to the UCITS Directive.”

AIFMD was implemented in region EU as a European Directive; however, each EU country was required to adopt AIFMD and additionally could “top up” the Directive with “gold plating provisions”, or other requirements specific to their country. 

In relation to each country’s conclusions on whether a fund is characterized as an “AIF” under their local rules (or not), there have been attempts to harmonize the AIF definition across the EU; however, the AIF definition may vary from one country to the next, depending on how AIFMD has been implemented locally and the NCA’s guidance on the AIF definition in their jurisdiction. This means it’s possible for an investment product to be characterized as an AIF in one country – and at the same time fall outside the AIF definition in another country.

Can we assume our product’s characterization in our home jurisdiction is valid in foreign countries?

Not necessarily. 

This is a classic example of, “Thinking LOCALLY while acting GLOBALLY”. 

To demonstrate this concept, here is a recent example of comments we heard from a US investment manager: 

“My long only equity fund (no derivatives, no leverage) is (characterized as) a “private fund” in the US and is marketed to “Accredited Investors” including family offices under private placement exemptions available in the US for private funds. Naturally, my fund will be characterized as an “AIF” when we fundraise in region EU and it will be acceptable for us to market our fund to HNWIs and family offices in the EU and in all other jurisdictions outside the US under available exemptions everywhere (applying US regulatory treatment on an extraterritorial basis).”

To which we replied: 

“Please consult your fund’s legal Counsel that’s preparing your fund offering documentation and have Counsel confirm characterization of your fund in all countries in which it is marketed outside the US so that you can know which regulatory regime applies per country for the marketing of your fund. You cannot assume equal regulatory treatment in the US and outside the US.”

Fund Manager Reaction: (baffled & confused look, completely flummoxed)

This “wearing your local hat while acting globally” is always fraught with potential distribution risk.

Investment Product Characterization is a country-by-country CHECK

What you think about your product characterization in your home country should be confirmed by your legal Counsel before you start fundraising overseas. 

More importantly, your Counsel that is preparing the product’s offering documentation should confirm the characterization of your investment vehicle and the regulatory regime that will be utilized in every country in which the product is marketed. 

So it is a country-by-country check and “product clearance” process, which must be reflected in your product’s offering documentation.    

What happens if the product is offered in a jurisdiction using the wrong regulatory regime?

This could be a potential breach of the country’s marketing regulations. 

If you breach laws in foreign countries for the marketing of your investment product under the wrong regime, you could be subject to the 5-Key Distribution Risks: sanctions by the regulator, lawsuits from investors, rescission rights claims from investors, potential loss of your business franchise and damage to your reputation.

Why would you want to trigger any of these Distribution Risks? 

Read more about Distribution Risk in our Blog 5-Key Distribution Risks for Cross-Border Marketing

Are Regulators serious about enforcing their country’s marketing regulations?   

Many Regulators mean business when you breach their country’s regulatory regimes: A bellwether indicator of how serious the NCA is about sanctions enforcement is to investigate what sanctions are on the books for breaches of their country’s marketing regulations and/or the level of fines a regulator will impose for “bad actor” activity.  It’s also helpful to review actual sanctions enforcement activity in practice to gauge how serious the regulator is on enforcement. Since you are conducting a regulated activity in each jurisdiction, you have to prove at any time that you comply with each country’s rules on promotion of investment vehicles. 

Read more about enforcement in our Blog Punitive Fund Marketing Regulations Sanctions: Enforcement indicator?

Summary

Regulators expect you to comply with their regulations on marketing your investment product in their country. Compliance with the marketing regulations means you need to know what regulations apply and how the local regulator characterizes your product (and its structure) under their local rules.

Product characterization is KEY to your overseas fundraising campaign. If you don’t know how your product is characterized in local jurisdictions, how can you know what regulations apply to your product offering? Further, how can you comply with unknown regulations? 

Have your lawyers do the characterization work, then you will be clear on the rules to follow.

And once you know what rules apply, don’t forget to follow the compliance guidance in your Sales Road Map©!

Begin exploring SRMO now

www.salesroadmapsonline.com

Sales Road Maps Online®: “Transforming marketing compliance®”