The EU Cross Border Distribution regime: reverse enquiry in reverse?

The times they are a-changing...

On 2 August 2021, the EU's Cross-Border Distribution of Funds (CBDF) regime will come into effect.

The regime will introduce some of the most significant changes to the marketing of funds in the EU since the AIFMD was implemented - with consequences for managers in relation to how they conduct their marketing efforts and marketing materials.

Although the large majority of the CBDF provisions are framed with EU managers (only) in scope, the new rules - contained in a Regulation and a Directive - could also indirectly impact UK managers and other third country managers.

But does the CBDF regime spell trouble for reverse enquiry?

Marketing and the AIFMD

When agreeing on a specific definition in the AIFMD of what 'marketing' was (for AIFMD purposes), the legislators at least left it open to managers to continue to pursue a strategy of 'not marketing' - ie, relying solely on reverse enquiry.

However, from the outset, EU Member States have diverged in their interpretation of these rules and concepts - and there hasn't been much in the way of definitive guidance from the regulator at a European level.

Key issues under the CBDF

Note that the comments below will depend on how individual Member States choose to implement the CBDF - as we mention later in the note, we are already seeing divergence of approach between Member States in a number of areas and we will be tracking this closely.  

For non-EU managers, there are two principal issues in the CBDF regime that they will need to keep a careful eye on. And both may have a major bearing on how far a manager can look to rely on reverse enquiry as a strategy in the future.

These issues are (a) pre-marketing and (b) marketing communications.

Looking at these in turn

(a) Pre-marketing

The CBDF Directive brings in a new regime which will allow EU AIFMs marketing EU AIFs cross-border in the EU to test investor appetite without, at that stage, having to jump through the current registration for marketing hoops.

How would it work?

Provided the AIF hadn't yet been established and the fund documents aren't in final form, an EU AIFM would be allowed to start pre-marketing it to EU investors.

Within two weeks of starting to do so, the AIFM would have to send its home regulator an informal letter, informing it of:

• the EU Member States in which the pre-marketing has been taking place

• the period of time over which the pre-marketing has been taking place

• a brief description of the pre-marketing (for instance, information on the investment strategies presented) and

• a list of the AIFs which are being pre-marketed.

The AIFM's regulator would then inform the equivalent authority in each Member State in which pre-marketing is taking, or has taken, place.

However, if an investor from one of the Member States in which an AIF was pre-marketed subscribes to the fund (including under a reverse enquiry request) within 18 months of the AIFM starting to pre-market it in that Member State, this will be taken to be the result of 'marketing', in the AIFMD sense of the word.

This means two things - first, the AIFM must make sure it is registered to passport the AIF for marketing before it can take that investor in. And second, if the investment is deemed to be the result of 'marketing', it doesn't fall into the category of 'reverse enquiry'.

So, what does this mean for AIFMs?

On the face of it, the new rule looks helpful - it brings consistency to the rules in all the EU Member States and removes uncertainty as to how and when you can test investor interest in new funds.

However, the new rule could potentially restrict reverse enquiry as individual countries implement these rules - Germany, for example, has specifically extended the pre-marketing rules to non-EU AIFMs while others (such as Finland and the Netherlands) are imposing an 18 month reverse enquiry moratorium to all professional investors in their jurisdiction, whether or not the fund in question has been pre-marketed to them.

Even in a Member State which accepts that pre-marketing in that country and reverse enquiry are compatible, the AIFM concerned would still need to be clear (and able to demonstrate) that a reverse enquiry didn't in fact result from the investor having been sent information about the AIF prior to the AIF's establishment.

It seems likely, though, that if the AIFM receives a reverse enquiry from an investor and then sends that investor information about an AIF which has not been notified for pre-marketing, the AIFM would still be able to rely on reverse enquiry (though, as above, should make sure it is able to demonstrate that the investor's enquiry preceded receipt of the information regarding the AIF).

It's also unclear exactly what the situation is once the 18 months have passed - where an investor in a given Member State hasn't been pre-marketed to, it is probable that reverse enquiry would then be possible. But it seems far less likely that the end of the 18-month period somehow "cleanses" the previous pre-marketing, allowing investors to whom pre-marketed was directed to make use of reverse enquiry.

What about the impact on UK and other non-EU AIFMs?

As things stand, the UK won't be onshoring the new CBDF rules. As a result, there won't be a pre-marketing regime in respect of UK investors for the time being. (That said, under the UK's financial promotion regime, and the various exemptions allowed under it, some form of pre-marketing of funds has long been permissible.)

But UK and other third country managers could be impacted if the EU27 Member States decide to extend the pre-marketing regime to third countries through their national private placement regimes (NPPRs).

Will that happen?

Quite possibly - as mentioned above, the German rules do extend the rules to third countries and other Member States are in the process of gold plating them in various ways. The Directive, though, does stress that its rules shouldn't have the effect of putting EU managers at a disadvantage to non-EU managers (a point which was also raised in the context of the European Commission's work to date on its review of the whole AIFMD regime).

(b) Marketing communications - guidelines

As well as the CBDF Directive, there is an associated, but separate, CBDF Regulation.

One topic which the Regulation introduces is a set of rules concerning "marketing communications" issued by or on behalf of EU AIFMs.

Put simply, the AIFM must ensure that marketing communications addressed to investors are identifiable as such and describe the risks and rewards of purchasing units or shares of an AIF in an equally prominent manner. Further, all information included in marketing communications must be fair, clear and not misleading.

The Regulation also specifies that there should be guidelines about how these rules should apply and, in May 2021, ESMA published a Final Report containing its Guidelines. This followed a public consultation, our summary of which can be foundhere.

The Guidelines still need to be formally published on the ESMA website and will only start to apply six months from that date.

As with the pre-marketing rules under the Directive, the UK is not currently intending to implement the marketing communications rules. But there could be an indirect impact on UK and other non-EU AIFMs, depending on local implementation.

(The rules on marketing communications will also apply to EU UCITS from the outset.)

What do the rules (and ESMA's guidelines) say?

The definition of "marketing communications" in the Regulation is very wide in scope and covers all communications (regardless of the medium used) which contain a direct or indirect offering or placement of units or shares of a fund to EU investors in the EU and which have a "marketing purpose" irrespective of the medium

This includes all messages advertising the fund or referring to its key characteristics - paper documents, press articles, interviews, advertisements, factsheets, radio messages, social media etc.

It also includes communications handed to distributors by a fund manager which are eventually addressed to investors or potential investors - even if the communications weren't meant to be handed down to investors or potential investors.

ESMA's guidelines require any "marketing communications" to be identified as such in the communication itself.

Interestingly, legal or regulatory documents (such as prospectuses, Article 23 disclosures under AIFMD and UCITS KIDs are explicitly not viewed as being "marketing communications", the thinking behind this seemingly being that "marketing" begins much earlier in the communication chain and that sharing these fund documents is simply the final piece of formally enabling investment in the fund rather than being a communication to bring that investment about.

One other class of documents that ESMA would consider not to be 'marketing communications' are corporate communications made by the fund manager which describe its activities or recent market developments but which do not refer to a specific fund or a group of funds.

While this is helpful, the guidelines go on to say that this does not apply if the fund manager has only one fund or a small number of funds which are implicitly identified in the corporate communication.

This, then, is potentially very unhelpful to smaller managers trying to run the argument that sharing generic information on the manager can still allow you to stay within a future reverse enquiry.

Note that pre-marketing materials are not subject to the ESMA marketing guidelines.

The ESMA guidelines have the potential to both erode reverse enquiry as (a) the manager would have to identify any marketing communication - whether it has been shared by you or by a third party - as being a "marketing communication") and (b) generic material on the manager potentially may be taken to be implicitly advertising an identifiable fund.

Two final points on reverse enquiry

(A) The European Commission's report on reverse enquiry

The CBDF Regulation contains one area which hasn't been fully fleshed out.

Recital 20 and Article 18 of the Regulation refer to the Commission being required to prepare a report on "reverse solicitation and demand on the own initiative of an investor. The report is meant to specify "the extent of that form of subscription to funds, its geographical distribution, including in third countries, and its impact on the passporting regime".

Although the report is due to be submitted to the Council of the EU and to the European parliament by 2 August 2021, there have to date been no documents made public showing the Commission's work. It is, though, interesting that the Regulation specifically hones in on reverse enquiry and the report may well shed light on the Commission's preferred direction of travel in this area. Yet another aspect to watch.

(B) ESMA's letter on reverse enquiry under MiFID - and its impact on MiFID marketing

This note has concentrated on the regimes that apply to AIFMs (and, to a lesser extent, UCITS) but it's important to bear in mind that there are also developments in relation to MiFID services

In January 2021, ESMA issued a public statementas a "reminder to firms on the MiFID 2 rules on reverse solicitation" in the context of the end of the UK's transition period.

The statement said that UK firms should be aware that, while investors in the EU can initiate reverse enquiry under MiFID for investment services, since the end of the UK's transition period on 31 December 2020, ESMA had seen "some questionable practices" by firms around reverse solicitation.

These include firms trying to circumvent general clauses in their terms of business or using pop-up "I agree" boxes where clients confirm that any transaction is executed at the exclusive initiative of the client.

ESMA's statement goes on to say that managers need to consider the entirety of the communications chain between the firm and investors - press releases, advertising, brochures, phone calls, meetings etc should be considered to determine whether the client or potential client has been subject to any solicitation, promotion or advertising in the EU. Where a manager is advertising to EU investors, then this doesn't constitute reverse enquiry and that there are sanctions for breaching those rules - specifically criminal proceedings and loss of investor protections.

Looking ahead?

It may be that we are seeing the start of a policy shift within the EU towards a position where if you are looking for investment from EU investors - the most realistic model for selling your fund in the EU will be through active marketing - i.e., through passporting or by registering a fund for marketing via a Member State's private placement regime.

On balance, though, it is likely that some form of reverse enquiry will continue to be permitted, though managers may well need to tread more carefully to make sure an investor approach is a good reverse enquiry - and, for EU managers and EU funds, the changes outlined above may well make reverse enquiry harder in practical terms.

We are waiting not only for the Commission's report under the CBDF Regulation (see above) but also its work on the overall review of the AIFMD - the Commission's first public consultation has only recently closed but the issues of marketing and reverse enquiry are certain to figure prominently as the review takes shape.

We will be continuing to monitor developments in this area closely over the coming months and reporting on anything of significance to our clients.