Will clubs and co-investments benefit from the AIFMD exemption for joint ventures? Melville Rodrigues considers recent guidance from the UK regulator
As a response to the market turmoil, investors have reassessed their approach to investing indirectly. They were left feeling helpless as real estate returns eroded and they were unable to assess relevant risks or influence managers’ strategic decisions. There has since been a marked trend of utilising clubs and other co-investment arrangements that are aimed at achieving greater control and transparency for investors, as well as manager-investor alignment and consensus.
With the Alternative Investment Fund Managers Directive (AIFMD) taking effect under domestic law in July of this year, managers need to assess whether these arrangements – existing or proposed – fall within the scope of the Directive, or within the exemption for ‘joint ventures’.
If the AIFMD joint venture exemption were not to apply, the club or co-investment arrangement would constitute (subject to other exemptions) an authorised investment fund (AIF) for the purposes of the AIFMD, and be subject to additional regulation that could cause a drag on performance. AIFs will need to be managed by an authorised investment fund manager (from the date the manager is authorised or July 2014, whichever is the earliest). The manager will be required to satisfy capital adequacy, risk management, transparency and other AIFMD compliance requirements.
In addition, a depositary will need to be appointed to monitor cash flows, ensure safekeeping of securities and have a general oversight role. However, if the arrangement constitutes a joint venture for AIFMD purposes, the arrangement will fall outside the scope of the legislation and the parties can set their own appropriate compliance standards.
Joint venture guidance
The exclusion for joint ventures was introduced late in the AIFMD legislative process and, curiously, is mentioned in a recital but not contained in an operative provision of the legislation. There is no definition of joint venture in the legislation, and the term does not have a precise meaning in EU law, nor one that is commonly accepted across the legal systems of member states.
The market needs consistent and practical guidance from the various EU bodies and national regulators on the meaning of ‘joint venture’ for the purposes of the AIFMD, while recognising the risk of becoming too prescriptive and narrow. The UK regulator – the
Financial Services Authority – has helpfully taken the lead* and made the following suggestions:
• The scope of the exemption should be linked to the AIFMD definition of AIFs: “collective investment undertakings…. which….raise capital from a number of investors, with a view to investing it…. for the benefit of those investors”.
There are aspects of this definition that are particularly relevant.
First, capital is invested on behalf of the investors, as opposed to those investors investing the capital themselves. Another AIFMD recital indicates that a venture that does not raise external capital is not an AIF.
Second, an AIF does not include an undertaking that is managed by its members jointly, rather than managed by a third party or by only some of the investors.
• A club or other co-investment arrangement needs to be assessed in the context of whether the parties have day-to-day control over its activities. The UK regulator also indicates that an arrangement in which not all the parties have day-to-day control may still be exempted as a joint venture.
Joint ventures are often “a marriage of equity and expertise, with one party having the necessary experience to carry out the day-to-day [fund] management and the equity partner being involved in making more key, strategic decisions.” The parties may hire an external manager. A key issue is whether the strategic, financial and operating decisions are under the control of all the parties – that is, they have a continuous involvement in the overall strategic management of the arrangement.
• The right to be consulted or give directions is not sufficient. No single party should be in a position to control the activities unilaterally. A material factor is whether strategic decisions require the unanimous consent of the parties sharing control.
For the parties to take part in strategic management it means that the number of parties needs to be sufficiently low for joint management. In a corporate venture an investor may exercise control through a nominee board appointment.
• If an arrangement changes so that not all parties have control, it does not necessarily mean that the arrangement ceases to be an AIFMD joint venture. For example, if at the time of establishment all parties had joint control but later one retires while remaining a party to the investment, the arrangement should not necessarily be transformed into an AIF.
• It may be helpful if the parties come together in relation to a proposed project before the structure is determined and capital raised, or the venture relates to a business that the parties are already carrying on. Do the parties have an existing relationship? In addition, a joint venture may have a policy focused on the achievement of commercial goals, rather than a defined investment policy.
Structure and substance
These suggestions place much emphasis on the parties maintaining ‘day-to-day’ control to benefit from the joint venture exemption. Day-to-day should be construed pragmatically – meaning routinely, and not necessarily every day. Also, in the context of a joint venture involving underlying property assets, the focus should be on fund or strategic day-to-day control – in other words, not extend to property management of the assets, since property management is not an AIFMD-regulated activity.
Both the legal structure and the ongoing substance of the arrangement will be material, in order to benefit from the AIFMD joint venture exemption. However, certain structures may be inappropriate – for example, a limited partnership where investor liability is linked to not being involved with management. It would be challenging to argue that limited partners take part in fund or strategic management.
The UK regulator has applied an interpretation to joint venture that is consistent with commercial practice and not overly prescriptive, and we must hope that other EU and national regulators support the UK regulator’s approach. If so, participants in a club or co-investment arrangement should know what is necessary to fall within the exemption, and thereby avoid the transformation into – and ‘slings and arrows’ of – an AIF.
*Financial Services Authority Consultation Paper 13/9 Implementation of the Alternative Investment Fund Managers Directive, March 2013
Melville Rodrigues is a partner at CMS Cameron McKenna