iGlobal Forum sat down with Dewi Habraken, Senior Director - Business Development, JTC and Jevgeniy Nesch, Investment Funds Partner AKD Luxembourg to discuss sourcing foreign capital.

Q: What are the first steps if I want to tap into the European capital market?

Jevgeniy Nesch: The first door a US fund manager can knock on to enter the European private market is the private placement of the manager’s existing Delaware or Cayman fund to European Union (EU) investors in each separate EU member state. In such cases, the fund manager should be compliant with the different National Private Placement Regimes (NPPR). The second door is pre-marketing (Dewi is going to elaborate a bit more on that), followed by the marketing of your newly established Luxembourg fund. There is also a “reverse solicitation door”, which cannot be a marketing strategy and hence isn’t always a good solution.

Q: That's a good segue. Why is reverse solicitation no longer a viable option for U.S. fund managers to attract investors, and what are the consequences? 

Dewi Habraken: Back in the day, before we went to the new AIFMD regulations, reverse solicitation was pretty simple. As a fund manager, you would get your investors to approach you and you would let them sign the reverse solicitation notification, which would essentially mean that you got that item tackled. 

Nowadays, since reverse solicitation doesn’t provide for the same level of investor protection and compliance with high regulatory standards, the European legislators aren't fond of reverse solicitation. Essentially, if you get 20 investors into your fund and 15 of those came in by reverse solicitation, you may get questions from the regulator. 

The regulator may receive the information about the way investors became LPs in the fund via different methods (e.g. on-site visits to the AIFM or fund administrator, etc.) That becomes an issue when something goes wrong with the fund, the returns are disappointing, and investors would like to get their money back. 

Jevgeniy Nesch: Indeed. A good lawyer of an unhappy investor will advise to check how was the fund sold to the investor and if respective laws have been complied with.  In case of non-compliance, this may lead to complaints with the regulator, subsequent fines or simply serve as a negotiation asset against the fund manager. Hence, it is advisable that the fund manager team ask themselves if they actually want to argue with the investor on the point of acceptance in the fund by applying the proper marketing regime. The risk is high that the investor will request the originally invested amount excluding all costs, expenses and negative performance of the fund.

Q: How can these U.S fund managers effectively utilize the European Union's pre-marketing regime to assess and test investor appetite for their fund strategy?

Dewi Habraken: Before we step into pre-marketing, let's clarify the other options. The most standard route is going via the NPPR in each separate European member state. That requires an authorization of the fund manager and/or fund registration process in each of those member states, which is costly and unnecessarily complicated for fund managers that only would like to test investor appetite.  

Only once the fund manager is authorized and/or the fund is registered in that specific EU member state to market or pre-market its fund strategy, it is permitted to move forward. Luckily, the European Union has adopted a similar approach to the U.S and created one European market for marketing purposes.

By using the AIFM directive, it's possible to get a blanket license to market a fund across all European member states. Furthermore, it has allowed authorized fund managers to initiate pre-marketing before they commence full-on marketing of their fund. Pre-marketing constitutes a regulated activity that involves pitching your fund’s strategy on a high-level basis, however you're not yet providing final information and subscription documentation. Instead it could simply be a high-level term sheet showcasing what the fund is going to do to test investor appetite. Signed commitments cannot be secured during that phase, soft commitments only. 

And as mentioned previously, if you don’t engage a third party for that pre-marketing phase, such as JTC, or have set up your own AIFM licensed management company (again costly and time consuming) to obtain (pre-) marketing authorization, you would have to obtain that authorization in each separate member state via the NPPR regime. It is important to note that in some European member states, it’s not possible to apply the national placement regime.

The Luxembourg regulator is very experienced and knows how to work with third-party AIFMs or third-party providers who open the possibility to pre-market the fund to US fund managers. It comes down to setting up an operational memorandum with the sales teams from the fund manager to see how they will interact with potential investors.

Once that is set up, it will be tracked by the service provider to ensure that we are aware of the pre-marketing activities at all times, especially when the regulator comes in and tests that At JTC, we've created a compliant, but lenient and flexible, solution to ensure that the capital raising process runs smoothly. We're getting a lot of traction with finding U.S. managers that want to enter the European market in this way.

Jevgeniy Nesch: As a legal advisor, I must sometimes play the devil’s advocate on the client side, because "the devil is in the details". As Dewi mentioned, there are a couple of different approaches that a U.S. fund manager can take to raise capital from European investors, and it is essential to understand the exact needs of a U.S. fund manager so that the right and most efficient regime is applied. AKD, as a law firm focusing on fund formation and operation from legal, regulatory and tax perspectives, can help you navigate through the applicable laws and regulations achieving the best possible outcome. At the end, it's not about making the right choice, it's about making a choice and making it right.

Q: To that end, why is Luxembourg the main gateway to LPs in Europe?

Jevgeniy Nesch: There are a couple of reasons. The historical reason, which is the most pragmatic one for U.S. fund managers, is that Luxembourg structures are the ones which keep opening the European market for U.S. managers for almost 40 years starting with the UCITS funds and continuing the success story with alternative investment funds. It is even more important to understand that if you have five to ten minutes for your pitch towards the investors, you don't want to lose precious time on talking about the legal structure if everybody knows exactly why and how it works.

Q: But how did it come to that development? 

Jevgeniy Nesch: Luxembourg was one of the early adopters of the fund regimes, did always apply pragmatic and business oriented approach and has made it possible to ensure the same high regulatory standards as anywhere else in Europe, even while providing the widest flexibility to the fund managers. In Luxembourg, we have the so-called “fund toolbox,” which has a bit the same concept like lego, where you can actually combine different elements and create the product that exactly fits your needs and the needs of the investors.

Q: How long does it generally take to set up and launch a Luxembourg parallel or standalone fund  to source foreign capital?

Dewi Habraken: It’s important to line up all service providers to set up your fund. Typically, from the moment of engagement, it’s between six to ten weeks to launch and onboard a fund. It’s good to note that European regulatory requirements differ from the U.S. and can be more stringent at times, which will require an extended onboarding time. A thorough assessment of the fund’s strategy and operations, and timely communication with regards to changed plans, will allow your service providers to give an accurate estimate in terms of onboarding timelines.  
 
Jevgeniy Nesch: Let me give you a couple of reasons why a Luxembourg fund, in particular in the legal form of a partnership is relatively fast to be established. The Luxembourg limited partnership regime has been developed, among other things, on the basis of the common law limited partnership system. There are two similar ones which are prominent: the common limited partnership (SCS) and the special limited partnership (SCSp). Those partnerships are very flexible and are comparable with the U.S. or U.K. limited partnerships. 

What happens in practice is that whenever we set up a parallel fund in Luxembourg, we do work hand-in-hand with U.S. law firms who have already done the heavy lifting in the U.S., providing for the majority of important points and provisions in the U.S. or Cayman limited partnership agreements and offering memoranda. In Luxembourg, we call it the “Luxembourg-ization" or "Luxification" work, meaning that we adapt the existing fund documentation so that it is consistent and compliant with Luxembourg law, keeping the documents structure and conceptual approach. It has a lot of benefits, one obvious of which is that the fund managers and the service providers feel very comfortable with the Luxembourg sleeve documentation and hence can focus on what they do best.