By Alan Keating, Executive Director, Head of European Product at MUFG Investor Services
The changing regulatory and political landscape worldwide has motivated US investment firms to expand geographically and court investors abroad. Europe is often the top contender given its large investor base and varied market, but its rigorous regulations have left US managers with questions around how to best establish a European presence.
In effect, US firms need to utilise robust operations, legal and compliance teams to identify the best product structures needed to succeed in Europe, which can be a huge undertaking and so should be considered carefully. Here are some of the important questions investment managers need to ask before making the hop across the pond.
Who and Where?
The first considerations managers need to address are: (1) to who they want to market their funds and services and (2) from where those individuals or firms operate. The most appropriate jurisdiction for domiciling a fund is dependent upon the markets a manager is looking to access.
Luxembourg and Ireland are strategically advantageous jurisdictions in Europe, primarily because they have been set up to serve neighbouring European markets as opposed to the southern European markets, such as Italy and Spain, which cater pre-dominantly to their own markets. Additionally, Luxembourg and Ireland tout strong track records of operating regulated markets and robust corporate governance environments.
What are your options?
Re-domicile in Europe: If a US investment manager is unable to market their fund to their preferred target audience through the NPPR, they can choose to re-domicile their funds in a European country. While this option has become less popular, it does offer the advantage of being able to bring their track record with them. That being said, re-domiciling in Europe can be costly and time-consuming.
Start a New Fund: If neither National Private Placement Regime (NPPR) distribution nor re-domiciling are feasible, then managers can look to establish new funds and structures within a European jurisdiction. These funds will allow for full distribution into all EU jurisdictions and can also be used for global distribution. However, establishing a new fund requires firms to set up an entirely new entity with no previous track record and may incur substantial initial legal and operational costs when registering the fund in certain markets.
UCITS or AIFs. What fund structure is best for you?
After deciding to domicile a fund in Europe, managers must decide on their preferred regulated fund structure – UCITS funds, a European harmonised product, or Alternative Investment Funds (AIFs) under the Alternative Investment Fund Management Directive (AIFMD), which looks to place hedge funds, private equity and any other alternative investment firms into a regulated framework.
UCITS can be sold across the EU and are by far the most popular fund product among international investors due to the reputation the structure has achieved over the last 15-20 years, the suitability for both retail and institutional investors and the protections that they offer investors. However, they are not without their disadvantages; despite this popularity and brand recognition, investment managers face challenges implementing some investment strategies within a strict rules based regime, as well as a high cost to set up and maintain a UCITS fund, meaning that UCITS funds are not always the best option.
Many investment management firms overlook the advantages of setting up Alternative Investment Firms (AIFs) under the AIFMD. Despite its comparatively recent inception and lack of brand recognition, AIFMD provides investment managers with several commercial advantages, including the ability to passport their AIFs across different European markets in a similar manner to the UCITS distribution regime.
US investment managers need not completely overhaul their structures to become compliant with AIFMD due to the similarity between AIFMD and US structures. Additionally, AIFMD offers greater flexibility for implementing alternative strategies, improved investor protection offered by new depositary standards and the enhanced transparency through new investor disclosure rules and mandatory reporting to competent authorities.
While a UCITS fund structure is still a useful option for US managers entering Europe, the institutional focus of AIFMD makes the AIF approach a viable option for alternatives managers with an institutional investor base.
Marketing in Europe
Regardless of the fund structure that investment managers decide on, they continue to look for ways to market to European investors without encountering significant regulatory hurdles and high taxes. That appetite has increased the popularity of using specially regulated vehicles known as Management Companies, or Mancos. These enable businesses outside of the EU to launch European-domiciled mirrors of funds elsewhere, typically in Ireland and Luxembourg.
While some companies including Legal and General Investment Management and JP Morgan Asset Management have adopted their own structures, many firms use third-party providers that have set up Mancos and provide a single, comprehensive provider of services, including administrative, custody and reporting services, for investment firms looking to domicile oversees. Additionally, third-party providers can advise less experienced fund managers on the entirety of the process – from considering when to domicile in Europe to remaining compliant with the various regulations.
The European market is too big to ignore and the number of US investment funds looking to domicile in Europe is rising. While there are plenty of opportunities and structures that US investors can take advantage of when marketing to clients and prospects in Europe, it is essential that they compare all of the options that are available to them, as no one size fits all.
It is important that US investment managers ask the right questions when entering Europe to determine the approach that is best for them. Managers can do this by looking at where and who their potential investors are, what limitations and opportunities stem from their current structure, if they are willing to invest high initial costs to capture growth in Europe and what structure fits those needs best.