Inside view: Passport limits and access to alternatives

Florence Stainier, partner, and Stefan Staedter, senior associate at law firm Arendt & Medernach SA (Luxembourg), explain why retail investors locked out of non-Ucits vehicles are in the spotlight.

Until 2011, cross-border fund distribution under the passport mechanism was limited exclusively to Ucits. Over decades, the Ucits passport has helped build a powerful brand that has enabled Luxembourg to gain its current position as a leading fund jurisdiction. 

Beyond this, the Luxembourg toolbox has periodically been enriched through the years with different types of non-Ucits vehicles as well. Some of these have been accessible to pure retail investors (Part II UCIs), while others have been destined for high-net-worth individuals subject to meeting certain legal prerequisites in terms of minimum investment and/or qualifications. However, these vehicles have not had the benefit of a cross-border passport. 

When the alternative investment fund managers directive (AIFMD) was adopted in 2011, the aim was to facilitate greater alternative investment fund (AIF) market integration, better coordinate the actions taken by supervisory authorities to address the potential risks posed by this activity to the financial system, and ensure appropriate levels of investor protection.

The AIFMD helped to create the EU AIF market while offering high-level protection to investors and facilitating cross-border fund distribution. Luxembourg, leveraging on its Ucits expertise, has richly benefited from the growing popularity of passporting under the AIFMD.

However, the AIFM marketing passport is limited to professional investors, meaning national EU AIF products have instead found themselves having to rely on the national private placement regime (NPPR) when launching marketing activities in other Member States. The same is true for Part II UCIs, which have enjoyed growing interest in recent years thanks to their eligibility for sale to retail investors, but which under the AIFM passport mechanism end up being restricted to professional investors alone.

Thus, the options for distributing EU products to non-professional investors are currently rather limited, with the European long-term investment fund (Eltif) being the only vehicle to benefit from a true cross-border distribution passport. 

There is still a market gap at EU level for the retail distribution of EU AIFs – one that demands attention for two reasons. 

On the one hand, the CMU 2.0 initiative has called for improvements in the product offering for Ucits/EU AIFs to professional and retail investors in order to get investments and savings flowing effectively across the EU. 

On the other hand, given the potentially higher returns of AIFs compared to traditional savings and in view of the advancing level of economic sophistication displayed by retail investors assisted by computational investment technology, retail demand for EU AIF investment opportunities is on the rise. Several asset managers have leveraged on this demand by setting up Eltifs, with Luxembourg, France and Italy (home to more than 90% of existing Eltifs at present) viewed as pioneer jurisdictions in this respect. 

Although the total number of Eltifs in the EU – now 28 – is predicted to increase following the planned adjustments to the Eltif regime, clearly, the regime (which was initially created for closed-ended EU AIFs and facilitates investment only in particular asset classes) will not be completely redesigned. Thus, some demand for EU AIF cross-border investment opportunities will remain unsatisfied. In particular, it will still be the case that evergreen EU AIF strategies and EU AIFs investing in fund-of-fund strategies or non-traditional asset classes are marketable to retail investors only under the NPPR.

The MiFID quick-fix project created the expectation that the access conditions to professional investor status would be relaxed somewhat, and that non-complex AIFs might come to be marketable on an execution-only basis, meaning they could be sold on platforms. However, the project published on December 16, 2020 did not include these anticipated measures, and the matter has now been pushed to the forthcoming MiFID review. 

In the meantime, market participants are continuing to advocate for a greater ability to reach large numbers of retail investors, granting them better access to the investment opportunities offered by capital markets and helping them more thoroughly address their retirement needs. 

This would also further the aim of channelling long-term savings to companies and improving their access to financing, thereby hastening economic recovery and the green and digital transitions. 

With the most Eltifs and Part II UCIs of any country, Luxembourg is positioning itself as a domicile with a more extensive retail investment product offering. If the intention is now to close the EU-level market gap for retail AIFs, it would be exceedingly helpful to grant more flexibility (i) for Eltifs, particularly in terms of asset classes; and (ii) in the opt-in criteria for professional investors under the MiFID regime.

© 2021 funds europe

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