​By Isabel Rodriguez King & Wood Mallesons’ Madrid office.

Directive 2011/61/EU, on Alternative Investment Fund Managers (“AIFMD,” hereinafter the “Directive“) entered into force on July 22, 2011, with a deadline for transposition by the Member States of July 22, 2013. This Directive was transposed into Spanish law by virtue of Law 22/2014 of November 12, which also amended Law 25/2005, governing the former legal framework for private equity.

Despite foreseeable initial concerns regarding the new legal framework, it is safe to say that, in general, the market has been able to easily adapt to the new rules. However, certain inefficiencies requiring correction have become clear, several of which are based on a lack of consistency in application of the regulations by each Member State, and others which are based on mere technical defects in the relevant regulations.

In any event, the Directive already includes specific provisions for its subsequent review and amendment, in relation to which the two main issues pending at this time are, on the one hand, extension of the passport governed by the Directive to third countries and, on the other hand, the implementation of Article 69, which reads as follows: “By 22 July 2017, the Commission shall, on the basis of public consultation and in the light of the discussions with competent authorities, start a review on the application and the scope of this Directive.  That review shall analyze the experience acquired in applying this Directive, its impact on investors, funds or managers, both in the Union and in third countries, and the degree to which the objectives of this Directive have been achieved. The Commission shall, if necessary, propose appropriate amendments. The review shall include a general survey of the functioning of the rules in this Directive and the experience acquired in applying them.

Timely compliance with the July 2017 deadline seems highly unlikely at this time with issues such as the political situation in Europe, and in particular Brexit, giving reason to believe that compliance with this deadline will undoubtedly be delayed.

On the other hand, the regimes applicable to European Venture Capital Funds (“EuVECA”) and European Social Entrepreneurship Funds (“EuSEF”)[1] are also under review given the present lack of acceptance of such entities in the market.

The key aspects of some of the main amendments that should be expected to be made in the short and medium-term to current regulations governing alternative investment products are briefly analyzed below.

Alternative Investment Fund Managers Directive

1. Third-Country PassportsEuropean fund managers are required to obtain relevant authorization before activating their passport and engaging in cross-border marketing and management within the European Union.

This Directive planned to make passports available to managers and funds from third countries, subject to compliance with certain conditions, but the 2015 date initially set for such purpose was not met and no significant advances have been made since.

In July 2016, the European Securities and Markets Authority (“ESMA”) issued a public recommendation for extension of the passport (albeit with some caution) to twelve countries[2]: Australia, Bermuda, Canada, Cayman Islands, Guernsey, Hong Kong, Jersey, Japan, Isle of Man, Singapore, Switzerland, and the United States. However, the final decision rests with the Commission who, for the time being, has not issued a decision. Brexit has had a particular impact in this regard and all signs seem to indicate that the matter will not be resolved until the terms of the UK’s exit from the European Union have been negotiated.

Generally speaking, this rule would have allowed managers from third countries to access the passport, subject to compliance with the conditions set forth in the Directive and to obtaining the relevant authorization. In the meantime, while this procedure is being implemented, third country operators are free to market their products in the EU subject to compliance with the regulations of the relevant Member State (National Private Placement Regimes) (to the extent said regulations still exist as these were de facto replaced in some countries at the time of transposition) and, in all cases, in accordance with certain provisions of the Directive. In fact, this Directive provides for a phasing out of said national regulations once the passport has been made fully accessible by third country managers, although this is not likely to occur until 2019.

It should also be noted that there are no regulatory restrictions preventing funds from investing in Europe or European investors from investing in third country funds at their own initiative if they so wish (reverse solicitation), even where there was no marketing per se. On the other hand, the Directive has no effect whatsoever on investors from third countries who may freely invest in European funds without being affected by this regulation.

The implementation of an effective, simple and flexible system for non-EU operators to access the passport is essential for business. Complying with regulations in each and every one of the Member States where a company intends to market –in many cases requiring compliance with very different requirements and demands–, in addition to registering with ESMA at the European level, can be a very complex and costly process and, therefore, is only possible for a select few. It is a proven fact that many small and medium managers forgo marketing in Europe for this very reason, which prevents European investors from accessing these products and, therefore, reduces their options, thus negatively affecting the profitability of their portfolios.

As already noted, the political pressure generated by Brexit will delay resolution of this issue, as all signs seem to indicate that the European Union hopes to prevent the UK from benefiting from a relaxation in the requirements for passport access by third countries at a time of high tension in negotiations.

2. Passport for Managers Falling Below Certain Thresholds

One of the main inefficiencies identified in the market since this Directive entered into force is the difficulty faced by many operators when it comes to cross-border marketing, in particular for those that have assets under management below the thresholds set by the Directive and who are therefore not required to comply with the Directive. Although operators may voluntarily submit to the requirements imposed by the Directive, many small managers have a hard time meeting these requirements.  Given that, in such case, they are unable to obtain the passport, they face significant difficulties and are even completely prevented from marketing in certain Member States that directly block these managers, even denying them the option to market in accordance with national regulations.

These obstacles not only negatively affect market competition in Europe but in practice, contradict the treaties and philosophy of the European Union.

Although some of these managers may be able to operate under the EuVECA framework, the conditions and restrictions under said framework have in practice resulted in most managers discarding this option, as further analyzed below. A potential solution to this problem, which affects a significant number of operators, could include revising the EuVECA framework or establishing a specific passport for smaller managers.

3. What is “Marketing”?

Another problem that has been clearly identified by managers, and which is particularly problematic at the start of each fundraising process, is the proper identification and interpretation of the marketing rules applicable in each Member State in which the manager intends to raise funds with a view to complying with all relevant regulatory requirements.

However, the definition of “marketing” in each Member State is not clear, in particular in relation to activities that could be considered “pre-marketing,” thus constituting a preparatory activity outside the scope of the regulations. Some countries consider effective marketing to have taken place only after the investor has received nearly final documents for signing, whereas others take a more conservative approach.

The practical consequence of this situation is that managers are required to spend an inordinate amount of time and money analyzing the regulations of each country, thus suffering numerous delays that negatively affect the fundraising process.

4. Regulatory Process for Cross-Border Marketing

In order to market a new fund in a Member State other than their country of incorporation, managers regulated by the Directive (i.e. managers with assets under management above established thresholds) are required to send notice to the competent authority in their country. This notice must include a description of the structure of the relevant fund and a copy of its instrument of incorporation (e.g. primarily the prospectus and regulations for Venture Capital and Private Equity firms). The regulatory authority then has up to twenty days to respond, before which the manager is not allowed to start any marketing activities.

The main problem that this has created is in the case of potential changes and amendments subsequently made to the relevant documents, as the regulations require that any substantial changes to the documents be reported to the supervisory authority, who will have up to one month to review and, as the case may be, approve said documents.[3] Throughout the marketing process several negotiations are held with potential investors in the fund that could result in significant changes to the documents, and it is easy to imagine how burdensome these obligations and deadlines could become. In fact, it is completely inefficient that each time new amendments to the terms and conditions of a fund are made a new version has to be sent to the authorities and that, even worse, the fund is required to wait a full month before implementing such changes and, as the case may be, before obtaining the green light to close the fund.

A similar problem surfaces in relation to the so-called side letters signed with certain investors and which are not included in the primary instrument of incorporation for the fund. This rule requires that all investors be made aware of the existence and content of said side letters. Although this is certainly an excellent practice that ensures total transparency in the process, the problem arises when it comes to compliance with such requirement. The regulation requires that the potential investor have this information prior to effective execution of their investment which, in practice, is not possible in a large majority of cases, as this type of negotiation agreement is reached throughout the process and tends to be made effective at the time of the relevant closings. This makes it impossible to anticipate the existence or content of any subsequent parallel agreements.

4. Definition of Professional Investor[4]This Directive provides that marketing may only be performed as between professional investors, as defined in MiFID II. However, this reference has turned out to be unsuitable to the business reality.

Many traditional investors are automatically qualified as professional investors under the terms of MiFID based on their nature as an institutional investor, but there are many other investors who despite being just as active on the market have difficulty or, in some cases, are unable to qualify as professional investors. This is the case for example with Family Offices or high net worth individuals which, although having a high level of sophistication and market knowledge, do not meet the criteria set forth in the regulations for being considered professional investors. However, these investors account for an increasingly significant amount of funds on the market and are essential for many managers, making the correction of this regulatory inefficiency a priority. The classification of these types of investors as retail investors makes compliance with marketing regulations in different countries more complicated, if not impossible.

5. Additional Issues

Although we have discussed certain aspects that have been identified as priorities in relation to revision of the application and impact of the Directive, additional issues are present which affect, to a greater or lesser extent, proper operation of the market. In a nutshell, the potential inefficiencies identified should be adjusted and corrected, and the appropriate principles of consistency and proportionality in relation to the aims sought by the Directive should be applied. This includes, inter alia, the principles of compensation, risk control, segregation of duties and alignment of interests; the scope of the Directive and the appropriate treatment of entities such as co-investment vehicles, which are increasingly common and sophisticated; depositaries and the need to grant a passport to service providers that facilitate operations and reduce costs; or the need to harmonize information and reporting principles, to name a few of the most relevant issues.

EuVECA and EuSEF Regimes

Regulations on EuVECA and EuSEF funds were implemented with the aim of improving access to capital for the managers of these funds. However, despite the laudable objective of these regulations, their expected advantages have not materialized, notably:

  • the opportunity to market to retail investors;
  • less oversight and regulation than alternative management activities governed under the Directive;
  • automatic marketing without a passport; or
  • exemption from the obligation to have a depositary.

In December 2016, the revision process was initiated addressing potential amendments to both regimes under the Capital Markets Union (“CMU”) Action Plan,[5] one of the priorities of which was, as stated by the European Commission itself, to provide easier access to capital for start-ups, SMEs and, in general, innovative businesses with high growth potential. Comparing the American market with ours, it is clear that a certain degree of support is still required for the proper implementation of alternative financing mechanisms in Europe. On the other hand, the recent financial crisis made the need for these sources when bank financing fails clear. Along these same lines, the above-mentioned CMU Plan includes other initiatives such as the launch of a Pan-European Venture Capital Fund of Funds or the proposal for tax incentives for venture capital and business angels.

Focusing on the regulatory aspects, the Commission has identified three fundamental obstacles to the effective application of the EuVECA and EuSEF regimes. Two of these obstacles are grounded in the content of the regulations:

  • limitations that govern the type of manager that can promote these types of funds;
  • restrictions on the type of investments that these funds can make; and
  • the third obstacle, which we consider external to the regulation itself and which is based on the application of fees and levies by various Members States for cross-border marketing and management of these products.

Along this line of action, the Commission proposed last year, in anticipation of the initial revision date, the amendment of both regulations, primarily in the following regards:

  • Expand the types of managers that can promote and manage these funds to all managers regulated by the Directive (currently only managers with assets under management below a certain threshold are allowed);
  • Extend the classification of assets these funds can invest in to include small mid-caps (unlisted companies with fewer than 500 employees). The current system only allows EuVECA funds to invest in unlisted companies with less than 250 employees, turnover below €50 million and an annual balance below €43 million.[6]
  • Simplify and lower costs associated with cross-border marketing, which currently prevent the full effectiveness in practice of the passport granted under these regimes.
  • In the case of EuSEF funds, reduce minimum investment requirements from €100,00 to €50,000.
  • Establish unified rules for all Member States on own equity requirements for these types of funds (1/8 of total costs from the prior fiscal year).
  • Establish a central registry of funds and EuVECA and EuSEF fund managers, to be managed by ESMA.

On March 22, 2016, the European Parliament confirmed that the members of its Committee on Economic and Monetary Affairs (“ECON”) were in support of the implementation of these and other amendments to both regulations in order to “make EuVECA and EuSEF funds more attractive for investors.”

Although as of the date of this report we are not certain when the legal and regulatory amendments briefly discussed above will take shape and be implemented, it seems indisputable that the European regulatory framework applicable to venture capital and private equity is still a long way from being finalized. Although changes and amendments to game rules already known are generally not welcomed by market operators, and despite the potential negative effects on business due to the uncertainty caused by such changes and amendments, we expect that, with a little bit of luck, most of the expected adjustments will be aimed at correcting errors, improving practices and eliminating inefficiencies existing under the current regime. 


[1] Regulation (EU) No 345/2013 and No 346/2013 of the European Parliament and of the Council both of 17 April 2013.

[2] See ESMA reports 2016/1138 and 2016/1140.

[3] See Art. 80.4 of Law 22/2014 and Art. 32.7 of Directive 2011/61/EU.

[4] See Art. 205 and Art. 206 of Royal Legislative Decree 4/2015 of October 23, approving the amended and restated text of the Spanish Securities Market Act.

[5] The Capital Markets Union Action Plan was issued in September 2015 and is a central component of the Investment Plan for Europe to foster employment and economic growth in Europe.

[6] Commission Recommendation 2003/361/EC of 6 May 2003, concerning the definition of micro, small and medium-sized enterprises.