Scope – Definition of AIF
Under the Directive, an alternative investment fund or “AIF” is:
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.
Both open-ended and closed-ended vehicles and listed and un-listed vehicles can be AIFs for the purposes of the Directive. The definition captures a broad range of vehicles that would be regarded as “funds”, including all non-UCITS investment funds, wherever established. The definition may also capture arrangements which may not be regarded as funds per se.
Please click here to access the Linklaters’ Knowledge Portal to view a flowchart setting out the steps for analysing whether an undertaking is an AIF. If you are not yet registered for access to the Linklaters’ Knowledge Portal, please email us to request access.
Whilst the basic AIF definition is broad, the Directive also contains exclusions to provide clarity that it does not apply to the following: (i) holding companies; (ii) institutions for occupational retirement provision (as covered by Directive 2003/41/EC); (iii) supra national institutions such as the World Bank and the International Monetary Fund; (iv) national central banks; (v) national and regional local governments and bodies or institutions which manage funds supporting social security and pension schemes; (vi) employee participation or saving schemes; and (vii) securitisation special purpose entities.
European level guidance
In its guidelines released on 13 August 2013, ESMAsought to define the key elements of the Directive definition of an AIF, noting that an entity will only be considered an AIF where all of the elements are present. For this purpose, ESMAconsiders that various concepts in the Directive definition require further guidance. Key elements of the ESMA guidance are as follows:
Collective investment undertaking - pooling and other criteria
The term “collective investment undertaking” is not defined either in the Directive or under European law, and is per se a very broad concept. ESMA has specified that one of the characteristics of a collective investment undertaking is that it “pools together capital raised from investors for the purpose of investment with a view to generating a pooled return for those investors”. ESMA notes that for the purpose of determining whether a pooled return is generated, no consideration should be given to whether investors in such undertaking are provided with different returns, such as under a tailored dividend policy.
Unit-holders or shareholders of the undertaking as a collective group should have no day-to-day discretion or control over the undertaking. Day-to-day discretion or control is defined in the ESMA final report as “a form of direct and on-going power of decision – whether exercised or not – over operational matters relating to the daily management of the undertakings’ assets and which extends substantially further than the ordinary exercise of decision or control through voting at shareholder meetings on matters such as mergers or liquidation, the election of shareholder representatives, the appointment of directors or auditors or the approval of annual accounts.” According to the ESMA final report, the fact that one or more but not all of the unit-holders or shareholders are granted day-to-day discretion or control should not be taken to show that the undertaking is not a collective investment undertaking.
ESMA notes that an undertaking with a general commercial purpose or industrial purpose should not be considered a collective investment undertaking. A “general commercial or industrial purpose” is defined as “the purpose of pursuing a business strategy which includes characteristics such as running predominantly (i) a commercial activity, involving the purchase, sale, and/or exchange of goods or commodities and/or the supply of non-financial services; or (ii) an industrial activity, involving the production of goods or construction of properties; or (iii) a combination thereof”.
- Raising capital
The guidelines contained in the ESMA final report specify that the criterion of raising capital would be fulfilled if there are direct or indirect steps taken by an undertaking or a person or entity acting on its behalf to procure the transfer or commitment of capital by one or more investors to an undertaking for the purpose of investing it in accordance with a defined investment policy.
No consideration should be given to whether such activity takes place once or on several occasions on an ongoing basis, or whether the transfer or commitment of capital takes the form of subscriptions in cash or in kind.
It is further noted that where a member of a pre-existing group invests alongside investors who are not members of a pre-existing group, the criterion of “raising capital” can still be fulfilled.
Number of investors
Whether an undertaking raises capital from a number of investors or not should be determined, according to the ESMA final report, by looking at the rules or instruments of incorporation of such undertaking, national law, or any other provision or arrangement of binding legal effect. If such provisions do not contain an enforceable obligation which restricts the sale of units/shares to a single investor, then such undertaking should be considered to be raising capital from a number of investors, regardless of whether the undertaking in fact only has a sole investor. Nominee arrangements, feeder structures and fund of funds should be considered to be representing a number of underlying beneficial owners only in the case that they themselves have more than one investor.
Defined investment policy
ESMA considers that a defined investment policy should be understood as being a “policy about how the pooled capital in the undertaking is to be managed to generate a pooled return for the investors from whom it has been raised”. ESMA sets out the following factors in its draft guidelines as being indicative of a defined investment policy, noting that the absence of all or any one of them would not conclusively demonstrate that no such policy exists:
the investment policy is determined and fixed, at the latest by the time that investors’ commitments to the undertaking become binding on them;
the investment policy is set out in a document which becomes part of or is referenced in the rules or instruments of incorporation of the undertaking;
the undertaking or the legal person managing the undertaking has an obligation (however arising) to investors, which is legally enforceable by them, to follow the investment policy, including all changes to it, and
- the investment policy specifies investment guidelines, with reference to criteria including any or all of the following:
Whilst an attempt has been made to harmonise the AIF definition across the EU, the AIF definition may vary from country to country depending on how the Directive has been implemented in any given jurisdiction and what guidance on the AIF definition may be issued by the regulator in the relevant jurisdiction. With that in mind, it is possible for an undertaking to be regarded as an AIF in one country and at the same time fall outside the AIF definition in another country.
Broadly speaking the UK has transposed the UK AIF definition directly from the Directive. However, in addition to the ESMA guidance the FCA has set out extensive guidance on UK implementation of the Directive, including commentary on:
(i) the definition of an AIF;
(ii) the factors it considers appropriate to take into account when determining what is an AIF;
(iii) examples of the commonest types of AIFs; and
(iv) examples of schemes that are not likely to be AIFs.
This additional guidance is particularly helpful in analysing grey areas and considering arguments as to why certain undertakings may fall outside of the AIF definition as implemented in the UK. Such grey areas include: carried interest vehicles, acquisition vehicles, joint ventures, co-investment structures and REITs. It is possible to distinguish certain arguments which may be particularly helpful in concluding that a particular structure is not an AIF. Please see below for some examples in this regard. However it is important to note that each specific fact pattern will need to be analysed on its own merits.
- Carried interest vehicles: A carried interest vehicle may not be regarded as an AIF because (i) it is classified as an employee participation scheme or (ii) there is an argument that the capital contribution made by the carried interest participants is so small that they should not be considered genuine “investors” for the purpose of the AIF definition.
- Acquisition vehicles: An acquisition vehicle may fall outside the AIF definition because the vehicle is not raising capital but is merely a means of deploying capital already raised.
- Joint ventures: There are two particularly prevalent arguments which may be used to suggest that a joint venture is not an AIF, namely (i) due to the joint venture governance model all of the parties have day-to-day discretion and control over the business; and (ii) no external capital is being raised by the undertaking on the basis that the joint venture parties themselves are providing the capital, such that parties raising and providing the capital are the same.
- Co-investment structures: The analysis with respect to co-investment structures may vary depending on the nature of the vehicles in question. For example, co-investment made by management may not constitute the raising of “external” capital. A co-investment undertaking which pools together capital from third party investors may fail the AIF test for similar reasons to the joint venture examples referred to above.
- REITs: a REIT may avoid being classified as an AIF by relying on (i) the holding company exemption, (ii) the fact that it has a general commercial or industrial purpose or (iii) that it does not have a defined investment policy.
Click here to access the FCA guidance in Part 16.2 (“What types of funds and businesses are caught?”) of its Perimeter Guidance manual (PERG). The FCA also provides guidance in PERG 16.6 on entities which are excluded from the AIF definition. Please click here for further details.
Open-Ended and Closed-Ended
For certain purposes, notably in the context of the small AIFM regime (click here), it is important to distinguish ‘open-ended’ from ‘closed-ended’ AIFs. The Commission has sought to clarify what is meant by these terms in its regulation on determining types of alternative investment fund managers published on 17 December 2013.
The Commission considers that the distinguishing factor in determining whether an AIFM is managing an open-ended or closed-ended AIF should be that on open-ended AIF is an AIF whose unitholders or shareholders have the right to repurchase or redeem their units or shares out of the assets of the AIF:
at the request of any of its shareholders or unitholders;
prior to the commencement of the AIF’s liquidation phase or wind-down; and
according to the procedures and frequency set out in its rules or instruments of incorporation, prospectus or offering documents.
Therefore a closed-ended AIF shall be any AIF not falling within the criteria described above. The Commission further notes that any AIF whose shares/units can be repurchased or redeemed after an initial period of at least 5 years during which redemption rights are not exercisable shall also be a closed-ended AIF.
The Commission further states in the regulation that an AIF may change between open-ended and closed-ended in the event that the redemption policy of such AIF changes.